The Banker's Blog Watch

Much has been written about the trading—not hedging—debacle at JPMorgan.  Jamie Dimon’s mea culpa is intended to head off deeper questions. No cover-up on his watch—get out in front, be direct, deal with it, move on.  Right?  Not so fast.

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“At base, having a small elite with vast wealth is good for the poor and the middle class.” 

This is how Adam Davidson’s piece in the New York Times Magazine summarized the frustrated former Bain Capital partner Edward Conard’s world view, as expressed in his forthcoming book, Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong.

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Joris speaks to a trader about City short-termism, high pay, the excitement of recent years and why he now wants a way out

o This monologue is part of a series in which people across the financial sector speak about their working lives

We are meeting in Lombard One, a restaurant in the heart of the City popular with financial types where a beer goes for £4.50. He is a confident man in his early 30s, the son of south-east Asian immigrants who now works as a derivatives trader, at director level. It's around 6.30pm and he orders a beer.

"Why trading? I read maths in university, and I love the beauty of it. Success in trading is binary. In areas like history, geography or languages, grey is the most obvious shade. Trading, at its core, is black and white. I have generated value today, or I haven't.

"Why trading? There was the glamour of it. You know, the money, the girls, rock and roll without the guitars. Another thing is, in trading you get to define yourself from an early age. You come in at 22 and you can prove yourself right away. I know guys making £1m a year at 25. This doesn't happen a lot, but it does happen and that's such a contrast with other jobs. As you know, investment banking breaks down into financial markets, where I work, and advisory, such as mergers & acquisitions. I could never be in M&A. A friend of mine works there. He was told in the first year he couldn't leave the M25 [London ring road], ever. He had to stay within a radius where he could be in the office within an hour.

"In M&A you don't really get to do anything of value in the first years. As these guys in your interviews are saying you work horrible hours, fidgeting with pitch books and getting the spacing right. Worst of all: if you sell advice, like M&A bankers, you almost have to puff yourself up. Why would clients pay for your advice, unless you are the smartest person on earth? It's a salesman's job - you know, a dirty job?

"If you don't come from money, you realise early on that actually, money is quite important. Let's say experienced traders like me can make anywhere between £300k and £1m a year. Meanwhile somebody fighting for our country in Afghanistan is making £22,000. It's funny how that works. When you ask me if that's fair, I also think of the guy who is making £5m, while I know I am smarter than he is. Life isn't fair.

"I come into the office around 7, in time for the 7.15 morning meeting. There'll be salespeople there, and traders. The traders will get up and give their ideas; basically they're telling the salespeople, this is what you should be pushing with clients. Salespeople have spoken to their regular clients, and they might say, there's massive client interest for this or that. You don't get much out of these morning meetings.

"At 8 the market opens, and I'll be responding to both clients and the market. It can be so hectic you can't even go to the toilets. Or so dull you end up doing your internet shopping.

"At 4.30 the business closes, you calculate your P&L (profits and losses) and file a report on why you made or lost money. Around 5.30 people begin to drift away. The more complex stuff you trade, the longer you need. If you have positions in the US, you may need to stay in as markets there are open until 9pm London time.

"Trading is a seductive world. In a bull market, with prices going up, basically everybody makes money. You ask yourself, was it me or just the market going up? It's tempting to attribute everything to your brilliance. What do I say to people claiming that a monkey with darts regularly outperforms traders? Well, for me the money hits the bank every month.

"I wish I could take you on the trading floor. There's no privacy, people are meant to overhear each other on the phone. The toilets are always in a horrible condition. I don't know why, because people on a trading floor are animals? It's just how it is.

"I love to be one of those people there, the energy, the buzz ... Weird thing is, sometimes you can feel the floor exhale before you see the price action on your screen that people are responding to. The price action might be a number coming out, say higher inflation or lower unemployment ... It's almost like an opera.

"There's jealousy, of course. People whispering "he had a really easy book to trade", after you had a good year. I'd say the low point is when everybody around you is making money and for some reason you are not. Everyone has bad periods, like sportspeople. You need to be strong, tell yourself "it's fine, I'm good". It's everyone's fear: to have lost "it".

"What is "it"? Call it intuition, call it the equivalent of what Messi can do with a ball. In the morning you ask traders who have "it", what do you think the market is going to do? And they go: "up". And up it goes. It's quite something.

"There seems to be this blanket anger towards bankers. It's as if you'd say: all sportspeople are bad, after some doping scandal or obnoxious misconduct by a footballer. Outsiders seem to think we're all the same. But even among traders, there is equity (shares), commodities (oil, grain etc), fixed income ... Within fixed income there are interest rates people and foreign exchange. Within equity there's say, the oil and gas sector, the financials sector etc - and these are completely different beasts from those trading CDOs (complex financial instruments).

"You've got prop traders who use the bank's money to make money for the bank. And flow traders, like me, who trade on behalf of clients. Again, a huge difference.

"For flow traders the holy grail is to become a prop trader, and be away from all the politics, salespeople, clients. "Prop" is the purest form of trading. It's dying out because regulators don't want banks to take risk with their own capital.

"How it works in flow trading. At the beginning of the day I have "a view" of how the market will go. On that basis I will take "positions". Then I wait for clients to call, or be called by our salespeople, who want to buy some of that position. We pocket a commission for doing so, and we may make money from the margin between what I bought the contracts for, and what I sold them on to clients for.

"I said earlier that the beauty of trading is the black and white, but actually there is grey. There's office politics involved when it gets decided what book you trade - for example, the oil and gas sector, or the financials sector. Clearly, there can be more client flow in one book than in another.

"Sometimes a client who is very important to the bank wants to do a trade you think isn't going to be profitable. Sometimes in the interest of holding on to that client you end up doing the trade. Then office politics kicks in because you want your manager to know you sacrificed your P&L. The industry is a microcosm of society, only more intense, sharper and more fast-paced.

"Traditionally banks and firms have cared only about so-called top-line revenue, the net number of how much money you made. But management should look below the line. Say you made a lot of money from one massive trade for a client. Is that really you? Also, firms should look at revenue in relation to risk. If nobody takes notice of the potential losses you exposed the bank to, then you get traders taking huge risks, obviously. Because the easiest way to make a lot of money is to take some massive position and hope it works out. 'Efficient use of capital' is the new buzzword. Capital used to be almost infinitely available. That's over.

"It's a valid question: do we, as a society, want 25-year-old traders making £1m a year? If not, you need regulation, on a global scale. The trouble is, regulators are idiots. I am sorry to put it so bluntly but you can't expect it any other way. If an investment bank hires a graduate, two years later they will be making over £100,000. Meanwhile at the regulators you are getting £30,000. Why would a smart, aggressive, competitive 22-year-old decide to work for the Financial Services Authority?

"You now have a generation who were told as graduates by their bank: we'll make your rich. They weren't taught to think in terms of risk. Basically at banks it's quite simple: if you are generating £100m a year in profits, you can be the biggest arsehole and get away with it.

"A thing that struck me going over the comments on your blog is that people seem to think all of us saw the crisis coming. But apart from Goldman and maybe Deutsche Bank, nobody expected this. I am also angry about the crisis. When I think of the CEO of some Wall Street bank that went bust, and he still has his $400m ... I mean, I owned shares in some of these banks, and they've gone to zero.

"Another thing is some people don't seem to understand risk. Risk per se is not bad. Banking is about properly pricing the risk of everything. There are very different sorts of risk, for traders. We seem to be seen as gamblers, but I know of few people who live up to that cliche. It's really quite hard to take a huge gamble. There's risk and compliance, you have risk limits you can't exceed. If you suddenly take a massive position, somebody will see it.

"Sometimes I hear outsiders say about trading 'I could do it'. When we hire people we tell them, you have to be comfortable with running an amount of risk every day of your working life. You end up thinking about it in your sleep, while you eat. It starts when you wake up and never goes away. On an emotional level, it's not that easy.

"In the old days, before the democratisation of knowledge, only a limited number of people had access to information. Our sales guys would get calls from clients who read something in the FT. These days clients go on the internet themselves. Our added value is a lot less. Investment banks have this army of analysts putting out research, salespeople peddling it to clients, traders ... Do we need all this?

"An element of panic is pervading the industry. What's our business model going to be? In the past 10 years I have never seen this pace of people dropping out. Pay will only go down. A lot of people are thinking, screw it, I'll survive as long as I can, take the money, and see what happens next.

"Generally the trading floor is meritocratic and I never felt any racism. A couple of pockets, like foreign exchange, are mostly populated by old school English white boys. No idea why that is.

"The trading floor is like a playground. I was in a minority in a white school and I have learnt to see how a comment about my background is meant. Jokes can be about your weight, hair, the university you went. It's an expression of camaraderie. There you are, sitting with two levels of screens in front of you, as in the trenches. You know that the guy to your right and the guy to your left both understand exactly what it is you're doing. We all have the same desire: to get on the floor, to make money.

"Derivatives flow traders have very little scope to rip off clients - a better word would be counter parties - actually, as these are professional investors. Multiple traders at multiple firms and banks can provide the kind of derivatives I am trading.

"In my experience salespeople have very weak technical knowledge of the products. If not, they would be trading themselves. With salespeople it's crucial they have this rapport with that really important client, so they can call him in bed at 10pm. We call this the ability to make the "first call in a non-standard environment". Say the shit hits the fan and we need to offload some inventory on a client. That's when you need the salesperson.

"Salespeople always want you to meet the clients, so they can say: here's my trader. Look at him. Just like a human being, he won't steal your children's inheritance.

"The repeal of the Glass-Stiegel Act allowed investment and retail banks to merge - that was a mistake in my view. There's no easy way to go back now. The Too Big To Fail banks have become even bigger. These banks will always find a way through. What so many people fail to grasp: banks are subject to the same discipline of quarterly earnings reports as the rest of the corporate world.

"Global heads of banks know: I have to make x billion in the next 18 months or I'm out. They can't say: it's going to be difficult for the next five years. The market demands results, from banks as much as from any other company.

"Bank CEOs are like salespeople. They are selling the dream to the outside world of how they are going to make the bank more profitable. The way it works, if you are a pension fund with shares in Morgan Stanley, and you see that Goldman Sachs made 50% more profit, you will not like that. These numbers make you look like a bad investor. So you put pressure on Morgan Stanley, saying, you have 18 months to prove you can turn this around or there'll be a sell-off.

"The short-termism is endemic. In my career I have almost never seen anyone trying to build something. There are just cycles of new guys coming in. They put forward a plan promising to make money in three or four years. So the pressure is huge, and the easiest way is take more risk. It doesn't always have to be obvious, visible risks, sometimes it can be "shadow" risks that are harder for outsiders to see.

"It's like an election cycle, really. You get new management coming in, and they will go for levers that can hit the revenue number within 18 months to three years. They go over the numbers and decide: this desk doesn't work. They fire the senior guy and bring in a new guy, for x million. New guy kicks out four more guys, and brings in his own. When after three years it hasn't worked out, the bank fires those five, and it starts all over.

"This is what a lot of people miss about Goldman Sachs. You look at most guys at the top there, they are Goldman guys. There's actually less short-termism there - for me their consistent management is one of their great strengths.

"Some managers are simply psychopaths. They come up to you on a day when you've lost money, and say: "you are losing money. Why are you losing money? Do you enjoy losing money?" I mean, that is not constructive, or is it? Management, on the whole, is terrible. You rarely get somebody who understands that managing me is not about competing with me, but about getting the best out of me.

"The City, or my niche in it, is like a club. Everybody knows everybody. We went to the same universities, at one time or another dated one another's girlfriends. It's relatively incestuous.

"The past few years were the most amazing, difficult, interesting times. Absolutely exhausting. In the morning you come in and RBS is down 40%. It's Sunday evening and you get a call: Lehman is about to go bust.

"That kind of excitement has washed by now. It's back to normal, the drudgery. I wonder, is this just what happens to people 10 years into a job? You get disillusioned? Everyone around me is thinking about exits. Then again, everyone in finance seems always to be playing with this idea of "getting out", of your "escape route".

"Banking is very honest, you can measure performance and keep score. On the other hand there are so many elements contributing to your performance that you do not control (market conditions, what product you trade, how interested clients are in what you offer them). So sometimes it feels like a very expensive prison term.

"Would I want my kids to work in finance? Most people would say no. Me too. I wouldn't feel they're adding anything. I find myself more and more interested in people who have built something. My life has revolved around a number on a screen for more than 10 years now. It can't be healthy to trade a number on a screen for your entire life?"

o Follow @JLbankingblog on Twitter

Joris talks to an academic about the pressure on students, the social skills of quants and the problem with financial models

o This monologue is part of a series in which people across the financial sector speak about their working lives

After the popular interview with a professor of economics at an Oxbridge college, here is a second economics professor, this time at a London-based institution. He is a cheerful man in his early 50s and a scientist by training.

"We are currently offering one course in ethics, taken by 10-20% of students. What would happen if we offered an entire semester with only ethical courses? I suspect many of our students would have serious problems passing those. If they had to engage with complex ethical issues in debates ... many would fail. These are people with a strong mathematical bent, the future 'quants', many with mild Asperger-like qualities.

"I am a quant myself, of sorts. I'd say the disconnect between quants and the rest of the world is an important key to understanding the financial sector today. If you allow me to generalise:

"Quants are extremely good at recognising patterns and structures, and at working in very detailed and systematic ways. Quants feel a strong psychological need for those structures, too, and they tend to presume the existence of such structures and patterns for the world to behave predictably, in ways that can be modelled.

"Quants don't have very good social skills. If you react to a quant in a way that requires empathy, this is difficult for them. Say two students are chatting over at the coffee machine. The quant professor recognises his student and stops to say 'look, I really didn't think your latest paper was good enough'. Then he walks on.

"For most people this would be hard to take; wrong time, wrong choice of words. The quant would fail to see the problem, as in his mind the professor has simply made use of an opportunity he saw to communicate something that needed communicating.

"The thing to take away from this: quants are more likely than others to miss certain aspects of social reality, as their brains are less attuned to them. When they then build a model, they are less likely to incorporate those aspects.

"How this works in the real world; a group of quants within a bank develops a financial product based on a model of the world they have built. They take this new financial product to senior management and say: look at this great new product we designed.

"Now, senior management is very unlikely to be comprised of quants, as quants usually lack the social skills to get very high up the management hierarchy. So senior management doesn't really understand what is being pitched to them. Then the quants have a real problem explaining it to them, because that's another social skill they are unlikely to have.

"What we need are people in senior management who know what questions to ask: about the assumptions underlying the model. About the model's vulnerability to yet unknown and unknowable factors. About the data set of the past 10 years used to project the product's revenue.

"But what senior management hears is this: we have this great product, and had we had it 10 years ago, we all would have made a lot of money.

"I do research and I teach. When I see my students go off on careers in the City I do wonder: can't society make better use of all that talent?

"Most of my students are very, very well aware of the kind of pay awaiting them: £50-£60,000 in their first year. Compare that to our beginning university lecturers. They have completed a bachelor, master and PhD, and will have done a minimum of one or two years of post-docs. Then they are given a three-year contract, maximum. Their salary is £25,000.

"The grades we give students determine if they are going to get that job in a bank and some don't hesitate to pass on the pressure, so to speak. I get students saying 'if I don't get that grade, my career is over'. I tell them that's rubbish, but this is how they are made to feel by the recruitment circus that banks and financial firms roll out. It's striking how quickly they get trapped in the nets cast by the financial industry. Student associations organise CV classes, literally from the first week. Students come under intense peer pressure to apply for internships, all highly competitive.

"I speak to students who are beginning to realise they won't get the grades necessary to even apply. They literally think their lives are over, 21-year-old kids who have been led to believe that either you get into a top paying bank, or it's a cardboard box under London Bridge.

"It's crazy but they've heard little else for three years. I like to say, provocatively: if this kind of brain washing were done by a religious movement rather than the financial sector, it would have been banned long ago. By the way, for foreigners there's a different dynamic as the British Border Agency won't extend their visa unless they get a job.

"I tell students, look at how banks treat you, do you really want to work for an employer that treats you like this? And I point out that there's a whole world out there between the bank where your bonus exceeds my yearly income, and that cardboard box under London Bridge. Most companies don't have the money for the kind of recruitment circus that big banks and financial consultancy firms put up. They still need graduates.

"The other day I spoke to an executive from a fast-growing IT company who needed graduates. He told me his company might be willing to contribute a £500 finder's fee. Haha. I mean, the gap between what banks can afford and £500 ... the guy had no idea.

"There is a generation gap between students and professors, clearly. Many of my colleagues conceive of a university education at least partly as Bildung, an opportunity for young people to discover, develop and realise themselves, and we believe society will benefit from that.

"Most of our students could not care less about all this. They conceive of us as a hurdle; a selection station to get through. They aren't here to learn, they are here to pass.

"My impression is that this is what recruitment people tell students, too: 'Doesn't matter how you do it, just meet your target. Get the right grade.' The right grade, then, is anything above the cut-off line established by banks for applications.

"Banks send out their offers for summer internships between February and April. These offers are always conditional; if you don't end in the upper-second class, there's no internship for you. Some students invest so much time in applications, they don't have enough time to actually study. They fail, then come to me and beg for a better grade.

"What happens to the teaching cadre is they decouple, you might say. If my students are only interested in passing tests, they say, then what's the point of trying to teach them anything beyond that? So I'll just concentrate my energies on my research, meanwhile giving students what they want.

"The thing is, 25% of our students are genuinely interested in economics. They lose out. We are thinking about offering special arrangements where they can meet like-minded students. So they can organise a lecture about an interesting economic topic, rather than how to get into Barclay's bank.

"The pressure on students is getting worse, with the economic downturn and positions becoming more scarce. One outcome is cheating. In the old days we were quite forgiving. Now, if you are caught, even with something minor, we kick you out.

"I have spoken to graduates hired over the summer who got laid off in December. 'Now I know why salaries are so high,' they tell me, 'so that we won't complain when from one day to the next we are made redundant.' They are not asking for pity, to be sure. But you can tell this experience is a bruising one, they are still in their formative years.

"I recognise what this Oxbridge professor says about students of Asian working-class immigrant parents. Many of them have told me how their parents asked them for a list of things they might like to study, and where. Then their parents made the choice for them.

"I worry this is sounding a bit bitter. I love teaching. The interaction with young people making their life decisions, it's fantastic. And I am enough of an idealist to think that if we ever want to change anything, this is where we need to start; the heads of these students.

"I celebrate as a victory every student I manage to talk out of a career in finance. Yet a possibly bigger victory is when they go into the City, but with a different and broader perspective. An uphill battle, well worth fighting.

"Has there been a reckoning among academic economists after the crisis? The thing is, they never treated their models the way banks did. As is often the case, the cause of abuse or ill use is the user, not the product itself. Academic economists know that a model is an approximation, a structure helping you understand what you see. Nothing more.

"As a physicist I am very interested in model building. My favourite example is the UK Met Office recent announcement they will no longer issue three-month predictions; they have decided that their models simply aren't good enough.

"Now imagine the Institute of Fiscal Studies saying, we will no longer announce projections for the next quarter, because our models simply aren't good enough. It wouldn't be accepted. They'd probably lose their subsidy. Try to imagine someone at a bank saying: look, you can't model that.

"A very challenging element in any economic model is trust and confidence. If I stop trusting the train I am on, that train will continue to ride just fine. But if people lose confidence in the economy, there are very real effects.

"Take inter-bank lending; banks lending money to each other. As we've seen during the crisis, sometimes banks stop trusting one another, leaving some exposed overnight because they can't access other banks' capital.

"Now, suppose as a regulator you suspect a risk brewing in the inter-bank lending market ... what do you do? The problem is that your intervention may bring about the very thing you're trying to prevent. If you intervene, you force banks to make their positions and exposure public. But that will have new reactions across the system.

"What makes it even more interesting is that people are not planets, so will top people at that bank share all they have? Do they have all the information themselves?

"I have worked at universities all my life. If you go and ask, how many PhD students do we have? You'd be amazed how difficult it can be to get an answer. Different departments may use different computer systems, they may use different definitions of a PhD student ... now imagine the complexity of a bank.

"My sense is that the Bank of England is quite aware of the need for a far more refined understanding of models and their vulnerabilities.

"To give you an example: the so-called Black-Scholes model is used to calculate today's value of derivatives contracts expiring in the future. That's been incredibly useful. There's one problem. Research shows that were everybody to use the Black-Scholes model, it would cease to work.

"Basically, the quest is for a model that remains unaffected by our knowledge of it. We need lots of talented young economists to delve into this. The trouble is, so much of that talent is sucked up by the banks.

"Ultimately this financial crisis is a crisis of sovereignty; national governments seem unable to exert decisive influence over the sector. I don't mean they will send a tank division into Canary Wharf. But if a national government is to maintain its credibility, sooner or later it will have to prove to its population that it is the ultimate arbiter. Something is going to have to give."

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O2 isn’t becoming a bank, but that doesn’t mean it won’t take some bank business.

In the wake of JP Morgan Chase’s startling news last week of its $2 billion trading loss, and of the equaling startling statements of Jamie DImon, the bank’s CEO, that the losing trades were, among other things, “flawed, complex, poorly reviewed, poorly executed, and poorly monitored,” there has been speculation whether these disclosures would lead to litigation. In particular, commentators have asked whether Dimon’s candid statements would hurt the company in any litigation that might arise.

Well, it looks like we will be finding out. On May 14, 2012, plaintiffs filed a securities class action in the Southern District of New York, against the bank; Dimon; Ina Drew, the bank’s former Chief Investment Officer: and Douglas Bronstein, the bank’s chief financial officer. A copy of the complaint can be found here.

According to the plaintiffs’’ lawyers’ May 14, 2012 press release (here), the complaint alleges that during the class period of April 13, 2012 through May 11, 2012, the defendants issued “materially false and misleading statements regarding certain securities trading by the Company’s Chief Investment Office (“CIO”). Specifically, Defendants misrepresented and/or failed to disclose that the CIO had engaged in extremely risky and speculative trades that exposed JPMorgan to significant losses.” The complaint specifically references the defendants’ reassuring statements made between the time the rumors about the trading activity first surfaced in April and the time of the disclosures of the trading losses, and blockbuster admissions about the trades.

The initial complaint is just 18 pages. Although the complaint quotes extensively from Dimon’s statements in a May 10, 2012 conference call, it does not refer to many other highly publicized features involved with the trading losses, including for example, the April rumors of trading activities by a JP Morgan trader labeled the “London whale,” whose trades had roiled the derivatives market (the complaint refers to the trades, just not to the “whale,” at least not by that name) nor Dimon’s statements to Meet the Press aired on Sunday May 13, 2012, that the bank had been “sloppy” and “stupid” and that he had been “dead wrong” when he characterized questions about the derivatives trades as a “tempest in a teapot.”

The complaint’s scienter allegations do not allege any motivations for alleged misrepresentations made during the relatively short class period. There are no allegations that any of the defendants’ traded on basis of allegations or that the defendants otherwise personally benefitted from the misrepresentations. The complaint does allege that the defendants did not believe their earlier statements about the bank’s derivatives trading activities at the time the statements were made. 

To be sure, it is not uncommon for an initial securities class action complaint to be skeletal, with more detailed allegations added in subsequent amended pleadings after lead counsel has been selected and the cases consolidated. Along those lines, there may well be other complaints filed on behalf of other prospective class representatives that may contain different or additional allegations. Subsequent complaints or amended complaints may well be more detailed. These complaints may also draw on subsequent news reports that JPMorgan’s senior management allegedly had disregarded “red flags” regarding the bank’s trading activities.

Even if they are able to add additional details, however, plaintiffs seeking to plead this case will be faced with the challenge of attempting to present scienter allegations sufficient to overcome the initial pleading hurdles. The defendants will argue that it is not enough for plaintiffs to rely on the magnitude of the losses or even on the fact that the losses resulted from a trading strategy that Dimon has now publicly acknowledges was flawed. In attempting to show that the early reassurances are not merely misleading but are actionable, the plaintiffs may find that they must allege more than the subsequent admissions about the trading activities.

How the securities class action plaintiffs will proceed and how they will fare remains to be seen. But in the meantime, there are now press reports circulating that the Department of Justice has “opened an inquiry” regarding the bank’s trading losses. The news of the DoJ inquiry follows prior reports that the SEC had opened a review of the developments. President Obama, among many others, has seized upon the bank’s trading losses as evidence of the need for greater bank regulation, including in particular the so-called “Volker Rule.”  Questions are also being raised whether the bank will or should seek to “claw back” compensation from the three trades who were released following the disclosure of the losses.

The fallout from the trading losses will continue to roil the markets and the media for some time to come, and could hound both Dimon and J.P. Morgan for some time as well. In the meantime, the private securities class action lawsuit will unfold, as these cases do, in the fullness of time. I will say that as interesting as it is that a securities class action complaint has been filed, it will be more interesting to see the plaintiffs’ allegations as they appear in the consolidated, amended complaint that ultimately will be filed.

A company’s D&O insurance policy provides liability protection for the company’s individual directors and officers, but only for their actions undertaken in their capacities as directors and officers. It does not protect them when they are acting in a personal capacity. So, when a company’s CEO signs a loan guaranty for the company, is he acting in an official or personal capacity, and will the D&O insurance policy provide protection for liability under the guaranty? Those were the questions addressed in a May 14, 2012 decision of a three-judge panel of the Court of Appeals of the State of Washington. A copy of the opinion can be found here.

Background

In March 2008, S-J Management LLC (SJM) obtained a $3.5 million line of credit from Commerce Bank. Michael Sauter, SJM’s CEO and manager, signed the loan agreement and promissory note in his official capacity on behalf of SJM. In addition Sauter provided Commerce Bank a guaranty, which he signed as “Michael J. Sauter” and which was secured by seven deeds of trust on real property owned by Sauter and his wife.

In May 2009, SJM’s line of credit matured and SJM failed to pay its indebtedness. Commerce Bank demanded that Sauter pay in full under his “personal guaranty of indebtedness” SJM’s $2.8 million obligation. Sauter in turn demanded that SJM indemnify him for the amount he was obligated to pay, to which SJM’s members (of which Sauter was one) agreed. However, SJM was financially unable to indemnify Sauter. After Commerce Bank threatened that Sauter’s failure to cure the default could result in the sale of the six real properties securing the guaranty, SJM’s counsel tendered the bank’s demand to SJM’s D&O insurer.

SJM’s insurer denied coverage with respect to Sauter’s obligation, and Sauter filed an action against the insurer seeking damages and a judicial declaration of coverage. The parties filed cross motions for summary judgment. The trial court denied Sauter’s motion but granted the insurer’s motion, holding that there was no coverage because no act by Sauter constituted a “Wrongful Act” under the policy and Sauter suffered no “Loss” as defined by the Policy. Sauter appealed.

The Appellate Court’s May 14, 2012 Opinion

In an opinion written for the three-judge panel by Judge Stephen J.  Dwyer and applying Washington law, the intermediate appellate court affirmed the trial court’s ruling. The court noted that the policy provides that an act by an “Insured Person” constitutes a “Wrongful Act” only when that person commits the act “while acting in [his or her] capacity as…such on behalf of the Insured Organization.” An “Insured Person” acts “in his capacity as ...such on behalf of the Insured Organization” when that person commits the act in his or her official capacity as a “director, officer, general partner, manager or equivalent executive” of the insured company.

In recognition of this language, the court said that because the policy “explicitly provides coverage for the personal liability of the corporate officer incurred for acts performed in his or her capacity as such,” the policy “does not insure against losses incurred where the officer acts in his or her personal capacity.”

The court said that “the fact that Sauter is an officer of SJM is not dispositive of the question presented,” which is -- in what capacity did Sauter sign the guaranty, his capacity as an officer or his personal capacity? The Court noted that “a guaranty executed by a corporate officer that secures the indebtedness of the corporation is not executed in the officers’ official capacity.” Indeed, the execution of the guaranty in an official capacity “would result in the corporation itself guaranteeing its own indebtedness, thus negating the very purpose of the guaranty.”

Because Sauter was acting in his personal capacity when he signed the guaranty, Sauter committed no “Wrongful Act” as defined in SJM’s D&O insurance policy, and thus the court concluded that the policy does not provide coverage for Sauter’s financial obligation to Commerce Bank.

The Court went on to note in addition that any purported “Loss” suffered by Sauter did not result from a “Claim” made against Sauter for a “Wrongful Act.” Rather, the court noted, “Sauter incurred the obligation to pay SJM’s indebtedness by executing the guaranty – not by failing to satisfy his obligation pursuant thereto.” In other words, the court said, “his obligation to Commerce Bank was not the result of Commerce Bank’s demand on the guaranty; instead his obligation was the result of the guaranty itself.” Accordingly, because his obligation to pay was the result of his voluntary undertaking, “it is not a ‘Loss resulting from any Claim … for a Wrongful Act.”

Discussion

D&O insurance policies protect individual directors and officers. But that protection does not extend to everything those individuals might do. Rather, the protection only extends to their actions undertaken in their capacities as directors and officers, not to actions undertaking in the personal capacities.

There principles are easy to state, but the lines of demarcation between actions undertaken in an official capacity and actions undertaken in a personal capacity may not always be clear. This case illustrates how the lines can sometimes be difficult to discern. Here, it was SJM that wanted to borrow the money, and Sauter was clearly motivated by a desire to facilitate SJM’s borrowing. What matters though is not his motivations but his actions. When he signed the loan agreement and the promissory note, he was clearly acting in his official capacity. But he separately signed a guaranty. Sauter’s guaranty was designed to obligate Sauter not the corporation, and his undertaking was clearly a separate, personal undertaken, as evidence by the fact that the guaranty was secured by deeds of trust on property owned by Sauter and his wife.

There is a further reason why Sauter’s guaranty should not be the responsibility of the insurance company. One cannot undertake an obligation to pay, default on that obligation, and send the bill to the insurance company. For that reason, many courts have held that as a matter of public policy repayment of a contractual obligation does not represent a Loss under a D&O insurance policy. As discussed here, many D&O policies incorporate express contractual liability exclusions.

Coverage disputes arising from the questions of whether or not an individual was or was not actin g in an insured capacity are occur frequently, particularly in connection with smaller or closely held corporations, when an individual’s roles may overlap or run together. It may sometimes be very difficult, for instance, in the context of a closely held company to distinguish when an individual is acting as an investor or shareholder and when the individual is acting as a director or officer.

Indeed, in many instances, individuals may have been acting in dual capacities or multiple capacities, which can make questions concerning coverage for related claims particularly challenging. One critical coverage issue that is sometimes overlooked in the dual capacity context is that to trigger coverage under most policies, an individual need only have been acting in an insured capacity – most policies do not require that the individual have been acting “solely” in an insured capacity. The problem then of course, if the individual is insured only to the extent he or she was acting in an insured capacity, is figuring out the extent of coverage. The fact that these kinds of disputes tend to be very fact-specific does not make them any easier to resolve.

Similar questions can also arise when a director or officer is also acting a director or officer of more than one entity or organization -- for example, where an individual is serving at the request of a private equity or venture capital firm on the board of a portfolio company. These concerns are among the many issues that may arise as a result of the interplay between the investment firm’s insurance and the portfolio company’s insurance, as discussed here.  

Many thanks to Aidan McCormick of DLA Piper for sending me a copy of the decision. DLA Piper represented the D&O insurer in this case.

"I scratch my head that somehow most of you on some academic level believe in the theory of supply and demand and how market setting prices result, but yet you deny them in your macro thinking about the economy.

I scratch my head that somehow your conclusions about unemployment are so different than mine and that you call for the printing of money to boost "demand". A call, I add, that since the founding of the Federal Reserve has resulted in an increase of the money supply by 12,230%.

So you then might tell me that stable prices are only a secondary goal of the Federal Reserve and that your real goal is to prevent serious declines in the economy but, since the start of the Fed, there have been 18 recessions including the Great Depression and the most recent Great Recession. These downturns have resulted in stock market crashes, tens of millions of unemployed and untold business bankruptcies."

"In this very building, deep in the underground vaults, sits billions of dollars of gold, held by the Federal Reserve  for foreign governments. The Federal Reserve gives regular tours of these vaults, even to school children. Yet, America's gold is off limits to seemingly everyone and has never been properly audited. Doesn't that seem odd to you? If nothing else, does anyone at the Fed know the quality and fineness of the gold at Fort Knox?

In conclusion, it is my belief  that from start to finish  the Fed is a failure. I believe faulty methodology is used, I believe that  the justification for the Fed, to bring price and economic stability, has never been a success. I repeat, prices since the start of the Fed have climbed by 2,241% and there have been over the same period 18 recessions. No one seems to care at the Fed about the gold supposedly backing up the gold certificates on the Fed balance sheet. The emperor has no clothes.

The noose is tightening on your organization, vast amounts of money printing are now required to keep your manipulated economy afloat. It will ultimately result in huge price inflation, or,  if you stop printing, another massive economic crash will occur. There is no other way out."

"Let's have one good meal here. Let's make it a feast. Then I ask you, I plead with you, I beg you all, walk out of here with me, never to come back. It's the moral and ethical thing to do. Nothing good goes on in this place. Let's lock the doors and leave the building to the spiders, moths and four-legged rats."

"Our analysis thus suggests that the danger of political polarization and extremism is greater in some national circumstances than others.  It is greatest in countries with relatively recent histories of democracy, with existing right wing extremist parties, and with electoral systems that create low hurdles to parliamentary representation of new parties.  

Above all, it is greatest where depressed economic conditions are allowed  to persist. "

"Catharsis calls for bringing to account those responsible for the crisis' origins and its consequences. ... Catharsis requires greater visibility, efficiency and accountability in a state governed by the rule of law. It also demands a better communication strategy that the sacrifices will pay off, are worth the effort and can indeed lead to 'resetting Greece' in the future. Greece needs a new growth agenda and a job creation perspective around which members of society can rally. Catharsis requires a shared sense that everyone can benefit in the long run from short-term sacrifices. This is particularly important for the young, access to education, which pays off, employment opportunities and trust by the new generations in the institutional geography of Greek politics."

"She was interviewing a psychopath.  She showed him a picture of a frightened face and asked him to identify the emotions.  He said he didn't know what the emotion was but it was the face people pulled just before he killed them."

"Their behavior is often regarded as evidence of traits which are sought-after in employment, in particular in senior positions, which have a broad scope of action and less clearly-defined duties, as well as helping them keep their jobs and climb the career ladder."

"At first view the existence of Corporate Psychopaths would appear to provide evidence for the bounded rationality of managers. However because they are ruthless and largely unaffected by the emotional consequences of what they do, they may actually operate as almost perfectly rational beings, with the important caveat that in making rational decisions they will put their own interests before those of the corporation they work for".

"Prior to the last third of the twentieth century large corporations were relatively stable, slow to change and the idea of a job for life was evident, with employees gradually rising through the corporate ranks until a position was reached beyond which they were not qualified by education, intellect or ability to go. In such a stable, slowly changing environment employees would get to know each other very well and Corporate Psychopaths would be noticeable and identifiable as undesirable managers because of their selfish egotistical personalities and other ethical defects."

• Moral Corporations: An Oxymoron?
• When Incentives Go Bad
• Frankenstein's Corporations

The swimwear and lingerie boutique “represents a continuation of her evolution,” from $2,000/hour hooker to budding entrepreneur.

Four years after her high-priced hotel romps with Eliot Spitzer dynamited his tenure as governor of New York and made her infamous, Ashley Dupré says she turned a page Monday with the opening of Femme by Ashley, a lingerie and swimwear boutique on the choicest block in downtown Red Bank. The shop, Dupré told redbankgreen in an exclusive interview, "is almost like the beginning of the rest of my life…Petite and wearing eyeglasses that made her appear somewhat more studious than she did in Girls Gone Wild videos made a decade ago, 27-year-old Dupré said she agreed to redbankgreen's request for a sit-down only at the urging of her boyfriend, TJ Earle, who thought it was important in establishing community roots. She said it would likely be her only interview on the topic. "I'm just done with it," Dupré said of her scandal-based persona. "I'm very private. People don't believe that, but I'm a very private person. I don't want that life. I'm not looking to be in the press. I'm just looking to get on with my life."

"I'm a girl, and I think every girl likes to shop and explore their tastes," she said. "Getting into this business, I kind of explored all of these designers and fell in love with them." The shop offers swimsuits in the $180 to $200 range as well as some "special" underthings, Dupré said.

Pop in for a look-see today.

ASHLEY DUPRÉ SETS UP SHOP AND MOVES ON [RedBankGreen via Daily Intel]

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Tags: Ashley Dupre, Eliot Spitzer, explorations, Femme by Ashley, it's like being born again, New Jersey, special underthings

Greece Teeters As Talks Fail (WSJ)
In a potent sign of Greeks’ rising anxiety, depositors withdrew EUR700 million ($898 million) from local banks on Monday alone, according to the country’s national bank--a significant escalation in capital flight from the country. Greek President Karolos Papoulias told party leaders that the situation facing Greece’s lenders was very difficult and that “the strength of banks is very weak right now,” according to a transcript released Tuesday.

Merkel: I Want Greece To Stay In The Euro (CNBC)
In an interview with CNBC’s “Worldwide Exchange,” Merkel said: “I want, just like Jean-Claude Juncker, that Greece stays in the euro. I think that would be good for Greece and for all of us. If Greece believes that we can find more stimulus in Europe in addition to the Memorandum (the deal stuck with the Troika), then we have to talk about that,” she said, but she underlined that Greece and its euro zone partners had to be able to trust each other.

What Happens When Greece’s Money Runs Out (Reuters)
“I’m really not sure Greece could survive for very long if external money was cut off,” said Darren Williams, economist at fund manager AllianceBernstein. “But what an experience of IOUs may do rather quickly is bring home to the average Greek citizen just how much more difficult a place it is outside the bailout program and outside the euro.”

Moore Leads Hedge Funds Betting on JPMorgan Before Losses (Bloomberg)
Hedge funds Moore Capital Management LLC and Blue Ridge Capital LLC boosted their stakes in JPMorgan Chase, while Kingdon Capital Management LLC divested, before the shares plunged because of a $2 billion trading loss. Moore, the $15 billion New York-based firm run by Louis Moore Bacon, bought 6 million shares of JPMorgan and its $297.3 million stake was its largest U.S. stock holding as of March 31, according to a filing yesterday with the Securities and Exchange Commission. John Griffin's New York-based Blue Ridge purchased 1.85 million shares, raising its stake in the bank to 6.14 million.

The man who beached 'Moby Iksil' (NYP)
Boaz Weinstein, a renowned CDS index arbitrageur who launched Saba in 2009, in early February recommended the index, which tracks a basket of US corporate bonds. "They are very attractive" and can be bought at a "very good discount," said Weinstein, a former Deutsche Bank proprietary trader, speaking at the Harbor Investment Conference on Feb. 2. It appears the index was so cheap because Iksil was buying it to make a big short bet. Weinstein, whose Saba overseas $5.5 billion in assets, decided to go long and said he bought the index a few days before the conference at around 120 basis points. For a while, Weinstein's genius trade wasn't working out. The IG9 Index continued to sink under the weight of the Whale's buys -- hitting a low of 105 on March 21. But two weeks later, on April 3, reports surfaced about the Whale's outsize positions and the tide started to turn. The price spiked to 130 as traders piled on. What JPMorgan CEO Jamie Dimon first termed a "tempest in a teapot" started to get serious. By last week, Dimon announced a $2.3 billion loss on the Whale's trade, and word spread that Iksil's head may roll. Meanwhile, Weinstein, who earned roughly $100 million last year, saw his position and the index continue to soar. The CDS index traded around 146 yesterday.

Facebook Said to Raise Size of IPO to 421 Million Shares (Bloomberg)
Facebook is boosting the number of shares for sale in its initial public offering to 421.2 million, allowing the world's most popular social network to raise as much as $16 billion. Existing holders will offer 241.2 million shares, compared with the 157.4 million they originally planned to sell, according to a regulatory filing today. Menlo Park, California- based Facebook and its existing holders had earlier planned to offer 337.4 million shares.

Soros's Firm Buys JPMorgan, Suntrust in First Quarter (Bloomberg)
The $25 billion Soros Fund Management LLC, based in New York, increased the value of its stake in financials by 7 percent, including 606,000 shares of JPMorgan worth $28 million as of March 31, and 3.2 million shares of Atlanta-based Suntrust valued at $77 million, according to a filing yesterday with the U.S. Securities and Exchange Commission.

Paulson Holds to Gold ETFs in First Quarter, Profits as Prices Rise (Reuters)
So that’s nice.

Housing Starts Probably Rebounded From a Five-Month Low (Bloomberg)
"Homebuilding is inching up pretty much everywhere in the U.S.," said Patrick Newport, an economist at IHS Global Insight in Lexington, Massachusetts. "The days when housing was a drag on the economy are behind us." Even so, "housing activity is at depressed levels," with foreclosures "still a problem for builders," he said.

Bloomberg Reporter Makes Wardrobe Adjustment On Camera (DM, NYO)
A microphone mishap led one television reporter from revealing a bit more than she expected.
When it became clear that one reporter’s mic was not working, the cameraman swapped over quickly to Sara Eisen. Clearly thinking she was off-camera, the Bloomberg News reporter was adjusting her skirt and smoothing out her undergarments. Because the camera swapped over to her sooner than expected, the financial-savvy viewers caught a glimpse of Ms Eisen’s underwear…In spite of the hiccup, Ms Eisen was able to brush her skirt down and get back to business. She flashed a quick, knowing smile and then moved right into the news about Spain’s banking system debate.

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A RARE slip-up by lawyers has helped to shed some rather interesting light on a high-profile legal battle, the details of which some of the largest Wall Street firms have been fighting to keep under wraps. In 2007 Overstock, a Utah-based online retailer, sued a dozen big brokers, alleging that they had caused its share price to fall sharply by helping their clients to engage in "naked" short selling.

In a normal short sale, the shares are borrowed (or at least "located") with a broker's help before being sold. In the naked version, there is no attempt to pre-borrow the stock or even check that it exists. This can create "fails to deliver", where the trade is not settled when it should be because there are not enough actual shares available for delivery. This messes with the laws of supply and demand, allowing shorting to take place beyond the natural limits set by the number of borrowable shares. Regulators have long frowned upon naked shorting. The rules against the practice have been tightened up a number of times over the past seven years.

As the pre-trial discovery period proceeded, Overstock narrowed its focus to two firms, Goldman Sachs and Merrill Lynch, now part of Bank of America. Just before the case was set to go to trial in California, however, the judge dismissed it on jurisdictional grounds, ruling that not enough of the alleged wrongdoing had taken place in the state. Overstock appealed and pushed for all of the evidence to be unsealed. The defendants argued that virtually everything should remain sealed, in part because the documents contained "trade secrets". Four media groups, including The Economist, jointly opposed a motion to seal on public-interest grounds. The judge decided that some of the documents should be released but stayed his ruling, pending appeal.

That was how things stood until the end of last week, when the defendants' lawyers sent their opposition to a plaintiffs' motion to the other parties in the case. One of the exhibits attached to this, presumably inadvertently, was an unredacted version of an earlier filing by Overstock, opposing the defendants' motion to seal papers. Within this exhibit is an intriguing six-page section, "Facts Defendants Improperly Seek to Seal" (pages 14-20 of this), containing excerpts of e-mails written by Goldman and Merrill employees.

In a number of these, they discuss deliberately failing to settle client trades. One Merrill executive suggests the firm "might want to consider allowing...customers to fail," to which a colleague replies: "We are going to look into that." Another asks: "How and when can we prevent the delivery [of shares]?" In another e-mail he requests an update from a lieutenant on "how we are going to fix fails and I want to know what we nees [sic] to do to make 369 market makers fail." In response to a question from a large client about efforts at "cleaning up" fails, a Goldman man says that "we will let you fail." In another message, he refers to a senior colleague "really backing down from...cleaning up fails."

Compliance officers repeatedly questioned this behaviour, according to the filing. A Merrill compliance person is quoted describing it as "totally unacceptable--we are failing when we have over a million shares of stock available...Is there a blanket agreement that we allow every market maker client to continue failing even if there is enough availability?" She adds that fails need to be "cleaned up regardless of who is causing them."

The e-mails also suggest close commercial links between the two firms and at least one trading outfit that was a target of regulatory probes into shorting violations, SBA Trading. In one message, a Merrill employee forwards a sanctions order against SBA's Scott Arenstein to a counterpart at Goldman, referring to Mr Arenstein as "our boy" and asking: "You think there will be any fallout on clearing firms?" The Overstock filing also refers to a telephone transcript in which a Merrill compliance officer and a colleague discuss the fact that Mr Arenstein's "recycling" of short sales is "not okay". In another e-mail, the deputy head of Goldman's securities-lending group describes Mr Arenstein as being "the other side of a lot of our activity."

Other missives suggest a cavalier attitude to the rules. In a 2005 e-mail, the president of one of Merrill's stock-clearing businesses responds to internal concerns about the intentional failing of short sales thus: "Fuck the compliance area--procedures, schmecedures." He has since assured the court that this statement was a joke, according to the filing.

Goldman and Merrill have denied throughout that they participated in any sort of naked-shorting conspiracy. Their supporters argue that the legal action brought by Overstock is a crude tactic by Patrick Byrne, the retailer's mercurial boss, to divert attention away from its long history of underperformance. (The firm continues to struggle, despite no longer being plagued by settlement failures.) Some question the link between failed trades and naked shorting, arguing that fails are generally the result of operational problems and other factors rather than naked nefariousness.

Nevertheless, the release of the e-mail excerpts will have done the brokers no favours. They suggest that trades were being intentionally failed; that some of those involved were aware regulators would not look kindly upon some of the activity; that some of the firms' internal policemen were unhappy with the explanations they received for the proliferation of fails; and that at least one senior executive appeared to have an unusual attitude towards compliance.

The e-mails are just a very small part of the communications and other material unearthed during the four-year discovery process. If the court of appeal unstays the partial unsealing order, there will be much more to pore over, shining more light on an issue that has hitherto been as frustratingly murky as it has been controversial.

A LARGE, mistaken, trading position take by J.P. Morgan, one of America's leading banks, already costing it more than $2 billion has become a weapon in major battles in Washington and the financial markets.

In Washington a crowd of politicians has used the incident to argue for more government involvement in banking, even if the ideas floated are muddled or counter-productive. In the financial markets the response has been more focused and carnivorous as other financial firms are trying to get ahead of any move Morgan might make to extricate itself from its trade. The company's share price, already down more than 9% on May 11th after the initial revelations, fell another 2% on early trading when markets reopened after the weekend on May 14th.

Morgan response to the incident has come on multiple levels. Jamie Dimon, its chief executive, appeared on a popular news show on Sunday to acknowledge fault for the trade ("a stupid thing that we should never have been done"), but also provide reassurance ("...but we are still going to earn a lot of money this quarter. So it isn't like this company is jeopoardised..."). Morgan's capital position does indeed remain strong and it is projected to earn record earnings for the year.

Internally, Morgan made key executive changes. The head of the department arranging the trade, Ina Drew, abruptly retired. A special committee to direct the response to the trade was established under the bank's former chief financial officer Mike Cavanagh, often rumoured as the leading candidate to one day succeed Mr Dimon. This will certainly be a trial by fire.

In the financial markets, various obscure indices tied to credit default swaps moved abruptly, as other firms took bets on what comprised Morgan's trade, and whether it was vulnerable to a squeeze. That raised the possibility of the loss quickly expanding. Under accounting rules they must be constantly marked to market.

A key questions are whether Morgan has the fortitude to withstand the short-term pain of trading-induced price movements that are not tied to the value of the assets underlying the swaps, and how much value in these assets really does exist. So far, Morgan has believed its efforts to minimise the damage from the trade would benefit from keeping information of its components from the broader market. Meanwhile, other banks have begun re-examining their own trading positions to ensure a similar problem cannot emerge.

Facebook lit up the blogosphere and news outlets last week when it introduced its budding App Center, an online...

A central tenet of Ally Financial's reorganization plan for its ResCap unit filed today is the company's continuing ability to grow its auto finance business. The question is, can Ally, in fact, grow that...

“Each of us in this room has warmed ourself at fires we did not build, and each of us has drunk from wells we did not dig.”

— Mark Shields, as heard, October 1997

I am not ashamed to confide, O Dearest and Most Equable of All Readers, that I have had a version of this particular post marinating in my brain for more than five years, from almost the first time I began laying finger to keyboard at this modest opinion emporium. Lord knows I have had numerous opportunities to release it over the intervening period, what with, in sequence, 20-something investment bankers, 30-something hedge fund traders, and 50-something private equity mavens each trumpeting to the stars the overweening brilliance and talent of their professional accomplishments to any and all who would listen, and to many who would not. For those among you who have noticed, the exposure and ridicule of hubris among the Great and Good, the not-so-great and not-so-good, and the patently pathetic yet surprisingly lucky has been an overarching concern and even gleeful entertainment in these pages. It is somewhat of a hobby of mine, undertaken and cultivated, if for no other reason, than to remind Your Humble Servant that he should indeed try strenuously to remain as humble as he can. Because he sure as shit isn’t anywhere near as clever or accomplished as he would like to pretend to be.

To date, what has typically stayed my hand is an acknowledgement that any efforts to puncture the iron-clad self regard of the self-appointed financial elite would be doubly futile. First, because they would blink stupidly at me (metaphorically) for completely missing the point of their unquestionable magnificence, and second, because it has always seemed to me that the only people impressed by these individuals’ autofellation have been themselves. In other words, my targets have historically been both too impervious and too self-evidently ridiculous to bother.

What has tipped my hand at last has been the appearance, at Megan McArdle’s blog site, of a really excellent guest post by entrepreneur and investor Jim Manzi. Mr. Manzi’s capitalist credentials are indisputable, so I was both impressed and heartened to read the words he excerpted there from his newly published book:

Many entrepreneurs hold the opinion that “I did it all on my own,” which may be well adapted to leadership success in certain situations, but it is objectively myopic. The entrepreneur relies on an ecosystem of venture capitalists, risk-taking purchasers, and so on. This ecosystem itself rests on a deeper foundation of collective, government-led enterprise. The delivery of our software, for example, depended on the existence of the Internet, which is the product of a series of government-sponsored R&D efforts, in combination with subsequent massive private commercial development. Government funding has been essential to much of the university science that entrepreneurs have exploited. Honest courts and police are required for functioning capital markets and protection of assets; physical infrastructure is required for the roads and running water without which we would not spend much time thinking about artificial intelligence software. At the absolute foundation, national armed forces protect the whole system against external aggression. All of our exciting technical and economic innovations ultimately require men to stand watch all night looking through Starlight scopes mounted on assault rifles—and die if necessary—to protect our commercial, law-bound society. Would you do this to protect a billionaire hedge-fund manager who sees his country as nothing more than lines on a map?

Add to this, in my world, the foundational infrastructure of global financial institutions and markets, the extraordinarily complex socioeconomic web of laws, regulations, and conventions which protect, foster, and enable investment and speculation, and the enormously capable and complex bureacratic platforms from which most traders, investment bankers, and investors operate, and you begin to appreciate that these self-proclaimed supermen resemble Prometheus wresting fire from Mount Olympus for the benefit of mankind far less than spoiled rich kids born on third base who grow up convinced they hit a triple. (Not to mention that most of these clowns got rich on a flying trapeze constructed over a free safety net composed of the taxes, retirement savings, and future debt repayment powers of tens of millions of their otherwise completely uncompensated and unrewarded fellow citizens.)

So let me just say that I remain completely unpersuaded that traders, bankers, and private equity investors who have made fortunes over the last ten years deserve to be unconstrained, unregulated, and untaxed because they did it all themselves. Bull—if I may be so bold—fucking-shit. Go pull the other one, sweetheart. I’ve worked in finance for more than two decades. You can’t fool me.¹

Now don’t get me wrong, children. I think America, for all its various and distressing faults, is a remarkable country. In most countries in most ages of the world, the rich made their money the old-fashioned way: they stole it or they inherited it. For the last 200 years or so, we have run an experiment here and in a few countries abroad where capitalists have been allowed to create vast wealth for themselves and others based on sheer effort, talent, and—undeniably—loads of good luck. This is a remarkably heartening history. It is the unyielding bedrock for the Rawlsian contract which we all seem to enter into at birth, a contract which states that we will not unnecessarily constrain or prevent the great accumulation of wealth in our fellow citizens, as long as we have, ab initio, some non-trivial reason to believe we ourselves could be such a winner.

Jim Manzi puts it well (emphasis mine):

the fundamental tension of democratic capitalism [is that] winners... require shared resources produced by the losers. That is, the market economy requires broad social consent. Why should those who lose out in market competition give it?

Why indeed? Because they hope and expect that they, too, have some chance to be winners. If society evolves in such a way that winning becomes hereditary, or winners can rig the game in their favor, or losers have no chance to become winners because the gap is too wide, watch out. Social contracts are only worth the paper they are written on. And paper can be torn up.

The Mark Shields quote featured above remains graven on my brain, more than 15 years after I first heard it at an otherwise forgettable conference. It is true on its face, to anyone who will admit it. The rich and the successful in any society enjoy their spoils and their comforts at the sufferance of those whose lives, sweat, and blood have helped them earn it. This is what makes the Randian fantasy of capitalist übermenschen living self-sufficient lives in a remote canyon in Colorado—or, for the less self-reliant, modern titan, a condominium on Lake Geneva—so ridiculous. Most of the fat, pampered hedge fund managers and private equity moguls I know couldn’t survive a week without access to Whole Foods’ prosciutto bar, much less potable water, heat, and edible foodstuffs.

The complex, modern, secure, comfortable, and predictable society which we all enjoy at this time in history comes at a cost. It is expensive. And yet that cost, at least in this country, is subsidized for the rich by millions of fellow citizens who charge them less than market rates solely in the hope that they, too, might win the lottery of hard work and success.² It would behoove you sundry Masters of the Universe—tech entrepreneur, corporate executive, and financial titan alike—to remember this fact. Because the rest of us have not forgotten it.

And we vote.


¹ And don’t try to pull the “self-made man” shit on me, either, bubeleh. I’m one, too. It’s not any kind of excuse.
² Would you deny this? How else do you explain that the aggregate tax burden in this country is so low compared to other advanced Western economies with comparable or superior standards of living? Please.

© 2011 The Epicurean Dealmaker. All rights reserved.

His vision, from the constantly passing bars,
has grown so weary that it cannot hold
anything else. It seems to him there are
a thousand bars; and behind the bars, no world.

As he paces in cramped circles, over and over,
the movement of his powerful soft strides
is like a ritual dance around a center
in which a mighty will stands paralyzed.

Only at times, the curtain of the pupils
lifts, quietly—. An image enters in,
rushes down through the tensed, arrested muscles,
plunges into the heart and is gone.

— Rainer Maria Rilke, “The Panther” ¹

Here’s another didactic little story. There are these two guys sitting together in a bar in the remote Alaskan wilderness. One of the guys is religious, the other’s an atheist, and they’re arguing about the existence of God with that special intensity that comes after about the fourth beer. And the atheist says, “Look, it’s not like I don’t have actual reasons for not believing in God. It’s not like I haven’t ever experimented with the whole God-and-prayer thing. Just last month, I got caught off away from the camp in that terrible blizzard, and I couldn’t see a thing, and I was totally lost, and it was fifty below, and so I did, I tried it: I fell to my knees in the snow and cried out, ‘God, if there is a God, I’m lost in this blizzard, and I’m gonna die if you don’t help me.’” And now, in the bar, the religious guy looks at the atheist all puzzled: “Well then, you must believe now,” he says. “After all, here you are, alive.” The atheist rolls his eyes like the religious guy is a total simp: “No, man, all that happened was that a couple Eskimos just happened to come wandering by, and they showed me the way back to the camp.”

— David Foster Wallace, This Is Water ²

We cannot know his legendary head
with eyes like ripening fruit. And yet his torso
is still suffused with brilliance from inside,
like a lamp, in which his gaze, now turned to low,

gleams in all its power. Otherwise
the curved breast could not dazzle you so, nor could
a smile run through the placid hips and thighs
to that dark center where procreation flared.

Otherwise this stone would seem defaced
beneath the translucent cascade of the shoulders
and would not glisten like a wild beast’s fur:

would not, from all the borders of itself,
burst like a star: for here there is no place
that does not see you. You must change your life.

— Rainer Maria Rilke, “Archaic Torso of Apollo” ³

Du mußt dein Leben ändern: You must change your life. That much is certain.

But I cannot tell you the way; you must find it yourself. For I am not a wise old fish, either.

Nel mezzo del cammin di nostra vita
mi ritrovai per una selva oscura,
ché la diritta via era smarrita.

¹ Rainer Maria Rilke, The Selected Poetry of Rainer Maria Rilke, ed. & trans. Stephen Mitchell. New York: Vintage International, 1989, pp. 24–25.
² David Foster Wallace, This Is Water: Some Thoughts, Delivered on a Significant Occasion, about Living a Compassionate Life. New York: Little, Brown and Company, 2009, pp. 16–23.
³ Rilke, op. cit., pp.60–61.


© 2012 The Epicurean Dealmaker. All rights reserved.

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