Books, Creative, Life and Death, Philosophy

The Razor’s Edge by W Somerset Maugham

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May be it is only my tendency to see philosophy everywhere, but I honestly believe Maugham’s works are the classics they are because of their deep philosophical underpinnings. Their strong plots and Maugham’s masterful storytelling help, but what makes them timeless is the fact that Maugham gives voice to the restlessness of our hearts, and puts in words the stirring uncertainties of our souls. Our questions have always been the same. Where do we come from? What are we doing here? And where are we headed? Quo vadis?

Of all the books of this kind that I have read, and I have read many, The Razor’s Edge takes on the last question most directly. When Larry says, out of the blue, “The dead look so awfully dead.” we get an idea of what his quest, and indeed the inquiry of the book, is going to be.

Larry Darrell is as close to human flawlessness as Maugham ever gets. His cynical disposition always produced vivid characters that were flawed human beings. We are used to snobbishness in Elliott Templeton, fear and hypocrisy in the vicar of Blackstable, self-loathing even in the self-image of Philip Carey, frivolity in Kitty Garstin, undue sternness in Walter Fane, the ludicrous buffoonery of Dirk Stroeve, abysmal cruelty in Charles Strickland, ultimate betrayal in Blanche Stroeve, fatal alcoholism in Sophie, incurable promiscuity in Mildred — an endless parade of gripping characters, everyone of them as far from human perfection as you and me.

But human perfection is what is sought and found in Larry Darrell. He is gentle, compassionate, single-mindedly hardworking, spiritually enlightened, simple and true, and even handsome (although Maugham couldn’t help but bring in some reservations about it). In one word, perfect. So it is only with an infinite amount of vanity that anybody can identify himself with Larry (as I secretly do). And it is a testament to Maugham’s mastery and skill that he could still make such an idealistic character human enough for some people to see themselves in him.

As I plod on with these review posts, I’m beginning to find them a bit useless. I feel that whatever needed to be said was already well said in the books to begin with. And, the books being classics, others have also said much about them. So why bother?

Let me wind up this post, and possibly this review series, with a couple of personal observations. I found it gratifying that Larry finally found enlightenment in my native land of Kerala. Written decades before the hippie exodus for spiritual fulfillment in India, this book is remarkably prescient. And, as a book on what life is all about, and how to live it to its spiritual fullness in our hectic age, The Razor’s Edge is a must read for everybody.

Columns, Quantitative Finance, The Wilmott Magazine

House of Cards

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We are in dire straits — no doubt about it. Our banks and financial edifices are collapsing. Those left standing also look shaky. Financial industry as a whole is battling to survive. And, as its front line warriors, we will bear the brunt of the bloodbath sure to ensue any minute now.

Ominous as it looks now, this dark hour will pass, as all the ones before it. How can we avoid such dark crises in the future? We can start by examining the root causes, the structural and systemic reasons, behind the current debacle. What are they? In my series of posts this month, I went through what I thought were the lessons to learn from the financial crisis. Here is what I think will happen.

The notion of risk management is sure to change in the coming years. Risk managers will have to be compensated enough so that top talent doesn’t always drift away from it into risk taking roles. Credit risk paradigms will be reviewed. Are credit limits and ratings the right tools? Will Off Balance Sheet instruments stay off the balance sheet? How will we account for leveraging?

Regulatory frameworks will change. They will become more intrusive, but hopefully more transparent and honest as well.

Upper management compensation schemes may change, but probably not much. Despite what the techies at the bottom think, those who reach the top are smart. They will think of some innovative ways of keeping their perks. Don’t worry; there will always be something to look forward to, as you climb the corporate ladder.

Nietzsche may be right, what doesn’t kill us, may eventually make us stronger. Hoping that this unprecedented financial crisis doesn’t kill us, let’s try to learn as much from it as possible.

Sections

Columns, Quantitative Finance, The Wilmott Magazine

Free Market Hypocrisy

Markets are not free, despite what the text books tell us. In mathematics, we verify the validity of equations by considering asymptotic or limiting cases. Let’s try the same trick on the statement about the markets being free.

If commodity markets were free, we would have no tariff restrictions, agricultural subsidies and other market skewing mechanisms at play. Heck, cocaine and heroine would be freely available. After all, there are willing buyers and sellers for those drugs. Indeed, drug lords would be respectable citizens belonging in country clubs rather than gun-totting cartels.

If labor markets were free, nobody would need a visa to go and work anywhere in the world. And, “equal pay for equal work” would be a true ideal across the globe, and nobody would whine about jobs being exported to third world countries.

Capital markets, at the receiving end of all the market turmoil of late, are highly regulated with capital adequacy and other Basel II requirements.

Derivatives markets, our neck of the woods, are a strange beast. It steps in and out of the capital markets as convenient and muddles up everything so that they will need us quants to explain it to them. We will get back to it in future columns.

So what exactly is free about the free market economy? It is free — as long as you deal in authorized commodities and products, operate within prescribed geographies, set aside as much capital as directed, and do not employ those you are not supposed to. By such creative redefinitions of terms like “free,” we can call even a high security prison free!

Don’t get me wrong. I wouldn’t advocate making all markets totally free. After all, opening the flood gates to the formidable Indian and Chinese talent can only adversely affect my salary levels. Nor am I suggesting that we deregulate everything and hope for the best. Far from it. All I am saying is that we need to be honest about what we mean by “free” in free markets, and understand and implement its meaning in a transparent way. I don’t know if it will help avoid a future financial meltdown, but it certainly can’t hurt.

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Columns, Quantitative Finance, The Wilmott Magazine

Quant Culprits

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Much has been said about the sins of the quants in their inability to model and price credit derivatives, especially Collateralized Debt Obligations (CDOs) and Mortgage Backed Securities (MBSs). In my opinion, it is not so much of a quant failure. After all, if you have the market data (especially default correlations) credit derivatives are not all that hard to price.

The failure was really in understanding how much credit and market risks were inter-related, given that they were independently managed using totally different paradigms. I think an overhauling is called for here, not merely in modeling and pricing credit risks, also in the paradigms and practices used in managing them.

Ultimately, we have to understand how the whole lifecycle of a trade is managed, and how various business units in a financial institution interact with each other bearing one common goal in mind. It is this fascination of mine with the “big picture” that inspired me to write The Principles of Quantitative Development, to be published by Wiley Finance in 2010.

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Columns, Quantitative Finance, The Wilmott Magazine

Where Credit is Due

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While the market risk managers are getting grilled for the financial debacle we are in, the credit controllers are walking around with that smug look that says, “Told you so!” But systemic reasons for the financial turmoil hide in our credit risk management practices as well.

We manage credit risk in two ways — by demanding collateral or by credit limit allocation. In the consumer credit market, they correspond to secure lending (home mortgages, for instance) and unsecured loans (say, credit lines). The latter clearly involves more credit risk, which is why you pay obscene interests on outstanding balances.

In dealing with financial counterparties, we use the same two paradigms. Collateral credit management is generally safe because the collateral involved cannot be used for multiple credit exposures. But when we assign each counterparty a credit limit based on their credit ratings, we have a problem. While the credit rating of a bank or a financial institution may be accurate, it is almost impossible to know how much credit is loaded against that entity (because options and derivatives are “off balance sheet” instruments). This situation is akin to a bank’s inability to check how much you have drawn against your other credit lines, when it offers you an overdraft facility.

The end result is that even in good times, the leverage against the credit rating can be dangerously high without counterparties realizing it. The ensuing painful deleveraging takes place when a credit event (such as lowering of the credit rating) occurs.

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Columns, Quantitative Finance, The Wilmott Magazine

Hedging Dilemma

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Ever wonder why those airfares are quick to climb, but slow to land? Well, you can blame the risk managers.

When the oil price hit $147 a barrel in July ’08, with all the pundits predicting sustained $200 levels, what would you have done if you were risk managing an airline’s exposure to fuel? You would have ran and paid an arm and a leg to hedge it. Hedging would essentially fix the price for your company around $150 level, no matter how the market moved. Now you sit back and relax, happy in the knowledge that you saved your firm potentially millions of dollars.

Then, to your horror, the oil price nosedives, and your firm is paying $100 more than it should for each barrel of oil. (Of course, airlines don’t buy WTI, but you know what I mean.) So, thanks to the risk managers’ honest work, airlines (and even countries) are now handing over huge sums of money to energy traders. Would you rather be a trader or a risk manager?

And, yes, the airfares will come down, but not before the risk managers take their due share of flak.

Sections

Columns, Quantitative Finance, The Wilmott Magazine

Risky Business

Just as 9/11 was more of an intelligence failure rather than a security lapse, the subprime debacle is a risk management breakdown, not merely a regulatory shortcoming. To do anything useful with this rather obvious insight, we need to understand why risk management failed, and how to correct it.

Risk management should be our first line of defense — it is a preventive mechanism, while regulatory framework (which also needs beefing up) is a curative, reactive second line.

The first reason for the inadequacy of risk management is the lack of glamour the risk controllers in a financial institution suffer from, when compared to their risk taking counterparts. (Glamour is a euphemism for salary.) If a risk taker does his job well, he makes money. He is a profit centre. On the other hand, if a risk controller does his job well, he ensures that the losses are not disproportionate. But in order to limit the downside, the risk controller has to limit the upside as well.

In a culture based on performance incentives, and where performance is measured in terms of profit, we can see why the risk controller’s job is sadly under-appreciated and under-compensated.

This imbalance has grave implications. It is the conflict between the risk takers and risk managers that enforces the corporate risk appetite. If the gamblers are being encouraged directly or indirectly, it is an indication of where the risk appetite lies. The question then is, was the risk appetite a little too strong?

The consequences of the lack of equilibrium between the risk manager and the risk taker are also equally troubling. The smarter ones among the risk management group slowly migrate to “profit generating” (read trading or Front Office) roles, thereby exacerbating the imbalance.

The talent migration and the consequent lack of control are not confined merely within the walls of a financial institution. Even regulatory bodies could not compete with the likes of Lehman brothers when hunting for top talent. The net result was that when the inevitable meltdown finally began, we were left with inadequate risk management and regulatory defenses.

Sections

Quantitative Finance, The Wilmott Magazine, Work and Life

Ambition vs. Greed

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Growing up in a place like India, I was told early in life that ambition was a bad thing to have. It had a negative connotation closer to greed than drive in its meaning. I suspect this connotation was rather universal at some point in time. Why else would Mark Anthony harp on Brutus calling Caesar ambitious?

Greed, or its euphemistic twin ambition, probably had some role to play in the pain and suffering of the current financial turmoil and the unfolding economic downturn. But, it is not just the greed of Wall Street. Let’s get real. Jon Steward may poke fun at the twenty something commodity trader earning his thirty million dollar bonus by pushing virtual nothingness around, but nobody complained when they were (or thought they were) making money. Greed is not confined to those who ran fifty billion dollar Ponzi schemes; it is also in those who put their (and other people’s) money in such schemes expecting a too-good-to-be-true rate of returns. They were also made of the sterner stuff.

Let’s be honest about it. We in the financial industry are in the business of making money, for others and for ourselves. We don’t get into this business for philanthropic or spiritual reasons. We get into it because we like the rewards. Because we know that “how to get rich quick” or “how to get even richer” is the easiest sell of all.

We hear a lot about how the CEOs and other fat cats made a lot of money while other normal folks suffered. It is true that the profits were “private” while the losses are public, which is probably why the bailout plan did not get much popular support. But with or without the public support, bailout plan or not, like it or not, the pain is going to be public.

Sure, the CEOs of financial institutions with their private jets and eye-popping bonuses were guilty of ambition, but the fat cats didn’t all work in a bank or a hedge fund. It is the legitimization of greed that fueled this debacle, and nobody is innocent of it.

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Books, Life and Death

Catch-22 by Joseph Heller

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I’m embarrassed to admit it, but I didn’t “get” Catch-22 the first time I read it. That was some twenty years ago, may be I was too young then. Halfway through my third read a few weeks ago, I suddenly realized – it was a caricature!

Caricatures are visual; or so I thought. Catch-22, however, is a literary caricature, the only one of its kind I have read. Looking for a story line in it that ridicules the blinding craziness of a cruelly crazy world is like looking for anguish in Guernica. It is everywhere and nowhere. Where shall I begin? I guess I will jot down the random impressions I got over my multiple reads.

Catch-22 includes one damning indictment on the laissez-faire, enterprise-loving, free market, capitalistic philosophy. It is in the form of the amiable, but ultimately heartless, Milo Minderbinder. With inconceivable pricing tactics, Milo’s enterprise makes money for his syndicate in which everybody has a share. What is good for the syndicate, therefore, has to be good for everybody, and we should be willing to suffer minor inconveniences like eating Egyptian cotton. During their purchasing trips, Yossarian and Dunbar have to put up with terrible working conditions, while Milo, mayor to countless towns and a deputy Shaw to Iran, enjoys all creature comforts and finer things in life. But, fret not, everybody has a share!

It is hard to miss the parallels between Milo and the CEOs of modern corporations, begging for public bailouts while holding on to their private jets. But Heller’s uncanny insights assume really troubling proportions when Milo privatizes international politics and wars for everybody’s good. If you have read The Confessions of an Economic Hitman, you would be worried that the warped exaggerations of Heller are still well within the realm of reality. The icing on the cake comes when someone actually demands his share — Milo gives him a worthless piece of paper, with all pomp and ceremony! Remind you of your Lehman minibonds? Life indeed is stranger than fiction.

But Milo’s exploits are but a minor side story in Catch-22. The major part of it is about crazy Yossarian’s insanity, which is about the only thing that makes sense in a world gone mad with war and greed and delusions of futile glory.

Yossarian’s comical, yet poignant dilemmas put the incongruities of life in an unbearably sharp focus for us. Why is it crazy to try to stay alive? Where is the glory in dying for some cause when death is the end of everything, including the cause and the glory?

Along with Yossarian, Heller parades a veritable army of characters so lifelike that you immediately see them among your friends and family, and even in yourself. Take, for instance, the Chaplin’s metaphysical musings, Appleby’s flawless athleticism, Orr’s dexterity, Colonel Cathcart’s feathers and black-eyes, General Peckam’s prolix prose, Doc Daneeka’s selfishness, Aarfy’s refusal to hear, Nately’s whore, Luciana’s love, Nurse Duckett’s body, the 107 year old Italian’s obnoxious words of wisdom, Major Major’s shyness, Major — de Caverley’s armyness — each a masterpiece in itself!

On second thought, I feel that this book is too big a chef d’oervre for me to attempt to review. All I can do is to recommend that you read it — at least twice. And leave you with my take-away from this under-rated epic.

Life itself is the ultimate catch 22, inescapable and water-tight in every possible way imaginable. The only way to make sense of life is to understand death. And the only way to understand death is to stop living. Don’t you feel like letting out a respectful whistle like Yossarian at this simple beauty of this catch of life? I do!

Corporate Life, Email Flotsam, Humor

Geeks

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I have been doing a bit of geeky stuff lately — writing WordPress plugins. Okay, it is because I’m suffering from a terrible writer’s block.

You see, I’m supposed to be working on my next book. I foolishly promised a couple of chapters of The Principles of Quantitative Development to my commissioning editor at John Wiley & Sons within a month; now I find myself writing everything other than those darned chapters! Including plugins. Coming to think of it, writing those chapters wouldn’t be any less geeky, would it?

That made me wonder… We all started off as geeks, didn’t we? No use denying it. Remember how our teachers loved us, and the sexy cheerleaders, well, didn’t? Later in life, due to exigencies of circumstances, we may have tried to lose our techie halo and simulate a managerial posture. But, in our moments of panic, we go back to our geek roots. At least, I do.

You think you don’t? Well, check out these geek jokes. If you find them funny, chances are your roots are not too different from mine.

Heisenberg was driving down the highway when he was pulled over for speeding. The officer says, “Do you know how fast you were going?” Heisenberg says, “No, but I do know where I am!”

Two Hydrogen atoms walk into a bar. One says, “I’ve lost my electron!” The other says, “Are you sure?” The first replies, “Yes, I’m positive…”

Geek Pickup Lines:

  • Tell me of this thing you humans call [dramatic pause] love.
  • If you turn me down now, I will become more drunk than you can possibly imagine.
  • They don’t call me Bones because I’m a doctor.
  • Your name is Leslie? Look, I can spell your name on my calculator!
  • What’s a nice girl like you doing in a wretched hive of scum and villainy like this?
  • You must be Windows 95 because you got me so unstable.
  • My ‘up-time’ is better than BSD.
  • I can tell by your emoticons that you’re looking for some company.
  • Is that an iPod mini in your pocket or are you just happy to see me.
  • Want to see my Red Hat?
  • If you won’t let me buy you a drink, at least let me fix your laptop.
  • You had me at “Hello World.”
  • Mind if I run a sniffer to see if your ports are open?
  • You make me want to upgrade my Tivo.
  • By looking at you I can tell you’re 36-25-36, which by the way are all perfect squares.
  • Jedi Mind Trick: “This is the geek you’re looking for.” [Waves hand]
  • You can put a Trojan on my Hard Drive anytime.
  • Have you ever Googled yourself?
  • How about we do a little peer-to-peer saliva swapping?
  • With my IQ and your body we could begin a race of genetic superchildren to conquer the earth.
  • What’s a girl like you doing in a place like this when there’s a Farscape marathon on right now on the Sci Fi channel.
  • I’m attracted to you so strongly, scientists will have to develop a fifth fundamental force.

What Makes 100%?

What does it mean to give MORE than 100%? Ever wonder about those people who say they are giving more than 100%? We have all been to those meetings where someone wants you to give over 100%. How about achieving 103%? What makes up 100% in life? Here’s a little mathematical formula that might help you answer these questions:

If:

A B C D E F G H I J K L M N O P Q R S T U V W X Y Z are represented as:

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

then H-A-R-D-W-O-R-K = 8+1+18+4+23+15+18+11 = 98%

and K-N-O-W-L-E-D-G-E = 11+14+15+23+12+5+4+7+5 = 96%

but A-T-T-I-T-U-D-E = 1+20+20+9+20+21+4+5 = 100%

and B-U-L-L-S-H-I-T = 2+21+12+12+19+8+9+20 = 103%

but look how far ass kissing will take you.

A-S-S-K-I-S-S-I-N-G = 1+19+19+11+9+19+19+9+14+7 = 118%

So, one can conclude with mathematical certainty that While Hard work and Knowledge will get you close, and Attitude will get you there, it’s the Bullshit and Ass kissing that will put you over the top.