Trading Mentality: The 8th Deadly Sin
My daughter has autism and we have become used to the many challenges that presents for our family, so when she put a quarter in the CD player of my car, I wasn't really fazed. The second quarter, she quickly inserted the next day; before anyone could stop her, which caused the CD to become jammed was in the scheme of things a minor annoyance. In fact, I am actually enjoying listening to the radio now. It's been so long. Unfortunately the new music seems to be less than compelling, but this afternoon I heard a sampled rap-type mix combining Nat King Cole's "Lush Life" including the lyric "I was wrong" overdubbed with Jim Cramer being pilloried by Jon Stewart and proclaiming "I was wrong". President Obama and others were also sampled talking AIG bonuses, the meltdown on Bear Stearns, etc.
The crux of some of the criticism leveled by Stewart and some of the other tidbits that were sampled in the song was....."You big money traders saw this coming a mile away and didn't do anything about it and you got paid millions before and after." I was kind of blown away that mainstream music was addressing these issues.
What really struck me about the song was that unfortunately for the potential enlightenment of the masses, it didn't really address that fact that if you were a trader you might very well have known the ultimate outcome of what was going on....or had a strong sense of it and still not have been in a position to do anything about it. Even if you strongly suspected that eventually a reckoning would come, timing is everything. Even if you were Warren Buffet, the longest of long-term investors, who has very little pressure to perform even on an annual basis, you might have proclaimed derivatives "Weapons of mass destruction" and still written many that came back and bit you in butt. The financial markets really don't allow many people to take very long-term positions regarding things they think are wrong or right, without trading around those positions. You just can't afford to stick with a position that's going against you for too long. Some guys who have the temperament (and authority) to take this kind of pain....like Carl Icahn when he shorted internet stocks a bit too early....make out like bandits after absorbing large hits.
It really struck me, that although Wall Street continues to employ some of the best and the brightest, the "trader mentality" (no offense Noah) means that you often have to ignore what you really believe in order to survive in the short to intermediate term. If you read the recent New York Times article How Lehman Brothers Got Its Real Estate Fix, you'll understand that the guys who have it right for a period of time during a big move, can often over-ride guys with experience who try to remind them that "It's never different this time." You may have also read about how Wall Street firms doubled down on the very same positions that were killing them, thinking they were oversold. Some players may have been hallucinating and thinking these bonds were going back to 100 cents on the dollar and everything was going to be fine, but my bet is most figured there would be a lot of blood, but the bonds were worth 50 cents on the dollar not 20 or 30. It's a trading mentality....why not just walk away from the asset, when there is so much uncertainty and no liquidity. As I have opined in the past, when a highly leverage-able bubble asset implodes it has its own gravitational force that sucks people in, even those who never played during the bubble. It takes experience to know to just stay away, unless you have a real long-term view and ability to hang with your position (my guess is residential foreclosure buyers are going to learn this lesson in spades).
It's not that Wall Street was dumb they were too smart by half. Many believed they could get out in time or trade their way out of losing positions and sure there were those who were just drunk on success, wealthy enough to not care about getting fired and playing with other people's money. In fact there were many of them and they were in positions of authority. A great example of this were the many commercial real estate players, who when they didn't make high bidder on a property they liked, wrote the mezzanine debt for the high bidder, who they thought overpaid, in hopes that if the winning bidder had an issue, they would own the property at a price they thought was fair. These guys thought they were super smart, but somehow it didn't occur to them that with so many others playing the same games, if the mezzanine debt defaulted, it was very likely going to be because the whole real estate hyper cycle had turned down and they would end up owning an asset in a downward spiral.
The Street and the country seems to still is be in the thrall of traders and the trading mentality, how else could Boaz Weinstein be allowed to lose $1.8 billion for Deutsche Bank, after the worst of the market debacle had already taken place and then head out to raise money for his own hedge fund, which is expected to start trading this summer.
As I sat down to write this article I went back and listened to some of Jon Stewart's tirade about how CNBC didn't question the fabrications being spouted by various CEOs and CFOs during the crisis and the misguided action in the markets caused by this lack of scrutiny. Even Stewart caught on to the fact that traders, some of whom don't beat their wives or kick their dogs, in addition to many individuals were being caught up in the whole package of lies and errant market action based on the misinformation.
In my mind the new sin of the market decline in this bubble cycle has been the....I can always get out/get short....trader mentality. No one remembered the "Roach Motel" rule of bull markets. It's easy to get in, but you can't always get out. Come to think of it, the trader mentality has permeated our entire culture. Can't afford the down payment on the house right now? take an option ARM and refi before the teaser rate expires. Hey the federal and state budgets look good! let's pork it up while we can. Can't take the pain of a downturn? let's lower rates and print money, we can always deal with it when the economy rebounds.
It's gonna be very interesting to see the future impacts of the lesson of the 8th deadly sin.
Posted by lars
Sat May 9th, 2009 10:10 PM
There will be reams written (in addition to the reams already written) about who to blame. The reality is that no class of society, whether elected-Government, appointed-Government, Republican, Democrat, the banking community, the legal profession, the investment banking community, US citizens or real estate professionals acquited themselves well.
All played a part in the havoc created, either through sins of omissions or comissions. Of course, not all individuals swilled the kool-aid, but no one area of society has clean hands.
The body-collective went nuts. The only positive I see is that we, who survived, will be able to say, "I remember when..."
Posted by cfranch
Sun May 10th, 2009 08:21 AM
While the trader mentality will almost always hurt the whales(pension funds, mutual funds etc) it can be very profitable for the minnows(individual traders). Unwinding large positions cannot be done quickly for the whales lest they cause a collapse in the asset they are trading. My buy or sell of 1000 shares of CSCO or other high volume stock is not going to effect the price very much. In fact I depend on the whales for price movement and try to jump on board the trend they are creating.
Posted by Noah
Sun May 10th, 2009 08:49 AM
never any offense taken Jeff! Interesting piece. You know, Lehman doubled down on their positions thinking the worst was over and played very tough when it came to trying to raise private capital. When the people with the money walked, and basically said see ya and your doubly toxic assets, Lehman failed. Trader mentality? Absolutely! And the fed was supposed to bail them out? So many cry out.
Even those that shorted RMBS back in 2005, knowing there was a housing bubble that was about to burst, and who turned out to be dead on, had to endure about 12-18 months of pain before that market did freeze up leaving those holding the bad stuck in the roach motel with no way out!
Traders now are confused as ever. Hope is a dangerous emotion that sometimes clouds denial or reality. It is this hope that will burn many many traders. What amazes me most is the last line in your 2nd to last paragraph:
"Can't take the pain of a downturn? let's lower rates and print money, we can always deal with it when the economy rebounds."
Forget printing, bailouts, rescues, fiscal stimulus, 18 lending facilities, shift of garbage to fed balance sheets, etc..Do people honestly think there will be no unintended consequences of these actions (higher rates, higher taxes). Who cares I guess right? As long as peoples portfolios go up, and they feel wealthy, so they can spend again, all is well in the good ole US of A. Until something happens that causes pain. And then we want more gov't response. What happens when the govt/fed cant respond because we have to pay the piper for past policy? We never learn and are such a short minded society focused on NOW!
Posted by iven
Sun May 10th, 2009 12:14 PM
This article also points out that studies show most people overestimate their intelligence. But the reality is only a small percentage of people get out in time before something collapses.
One can be a trader but I suspect those reading this website are not billion dollar hedge managers but instead rich individuals or smaller managers. Unless you spend 13hrs a day 6 days a week for years doing this as a profession dont expect to time markets.
So those trying to buy foreclosures, bank stocks, etc better do their homework and consider it a profession just like a hand surgeon doesnt go and do brain surgery the next day without proper study that takes time. Its the allure that since all you have to do is either buy or sell, that its easy. Consider that if the pros at Lehman made mistakes as pro's what does that say for the rest of us?
People who are reading this site are likely 90% better informed than the public, and articles here are fantastic, but flaws in human psychology lead to false promises of trading which include gambling and casinos.
Study hard, dont overestimate your ability until you reach a higher level of knowledge, question everything, be humble to risk.....and you WILL do well, or at least outperform the masses, which is all trading is, making a move someone else isnt since its a zero sum game.
Posted by Crying Game
Sun May 10th, 2009 10:11 PM
Jeff's post is an extraordinarily bare to the bones description of capitalism in action. Even when the Trader knows that his actions (in the aggregate) are going to have terrible consequences, he is working the margins on the trade-- its "in his nature." We know that Marxist socialism turned out not to be a great alternative, but do you guys think that the Feds, for example, should be calling a time-out when the rumpus room starts to really get crazy? Who decides? What are the interventions? Do you guys think about these issues-- do you have suggestions? Your site is terrific!
Posted by anonymous
Mon May 11th, 2009 04:54 AM
Great article in this week's Economist about the French system/model, which has received almost uniformly scorn from the UK/US. It's not looking so inferior at the moment. I was struck by the author writing that it is illegal in France for banks to write mortgages that the borrower can't afford. We could have used that.
Posted by jeff
Mon May 11th, 2009 09:39 AM
Lars, I agree with your assesment that everyone was to blame. But many in government and the citizenry can claim ignorance (many even go about proving it daily). Many on Wall Street know full well how these things end and with their compensation levels have difficulty making the same claim. What I think Wall Street can claim is ignorance of how severe asset cross correlations are when everyone is playing the same game.
Iven,
As noted above I think the zero sum game issue is really what has become the problem. When everyone acts and thinks like a trader....playing trends they don't actually believe in and figuring they can hit the door before the party is over, problems develop. We forgot since the last depression why banks and investment banks were seperated. I think it also becomes a problem when the entire general populous aspires to be rap stars and heiresses.