DISCUSSION Derivatives and Faith

by Yolanda Villafuerte _______18th November 2009
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by Bill Sharon

In 1987 I joined a relatively small cadre of mid-career hires at JP Morgan. I and my new colleagues were needed because we had experience in putting up large high tech buildings and Morgan had just begun their headquarters project at 60 Wall Street. In those days the employees of the bank numbered between 12-14,000 and virtually all of them had come up through the internal training program. Understanding how the firm worked for a new arrival in those days was difficult. There seemed to be interminable rites of passage until you were deemed trustworthy. Once that happened, things became more fluid.
In the early 90’s there was a massive culture shock. Meetings were held and everyone was informed that they no longer had “a job for life”. We would remain employed only if there was a fit between the needs of the organization and the skills we had to offer. Lunch was no longer free – literally, although it still remained cheaper than going outside to the local deli. We all understood, many for the first time, that we were employed at will.
What happened over the next nearly two decades is a well known story. Jobs that didn’t provide strategic advantage were outsourced. Jobs were shed at the slightest sign of economic troubles and firms convinced themselves that they had become more nimble. Certainly, here in the United States it was infinitely easier to get rid of employees than in France. Even the UK provided some protection for workers. We looked down our noses at the Europeans.
But something else happened at the same time. People began to see their present jobs as an opportunity to enhance their resumes. While it was easier for companies to get rid of the less productive people it became increasingly difficult to hang on to the folks at the other end of the spectrum. The alignment of personal goals with corporate goals became the result of happenstance rather than mutual agreement. Internal theft soared. In an appeal involving a case in Illinois, the US Chamber of Commerce stated that $60 – 120 billion is lost each year to internal theft and it is the primary cause of 1/3 of all business failures. On a retail level, 70% of the theft is internal – which begs the question of the utility of all those plastic tags and security guards.
This was the unintended consequences of a sea change in the relationship between employees and employers and it didn’t take very much time at all. I am reminded that when I went to work at Manhattan State Hospital in 1969 there were several people who walked the grounds with tin foil hats on their heads. They insisted that they had had experiences with extraterrestrials and depending on their malady the hats were to either enhance or prevent further communication. Now we have global conventions devoted to sharing ET information and recently the Vatican lent credulity to these efforts.
The value embodied by derivatives is a matter of faith. You have to believe that you will be paid a certain amount when the value of the underlying asset changes in one direction or the other. The value of that underlying asset is determined by another act of faith – you have to believe that the value represented by a fiat currency has value. It’s a lot to ask, especially when there doesn’t seem to be any concrete utility attached to these financial instruments. Only a very small fraction is actually hedging a position where the parties are engaged in a transaction involving a real “thing”. All the rest is speculation.
Sometimes belief systems fade, sometimes they collapse. Certainly the credibility of ET sightings has taken a while to change and not everyone who insists that they have seen one is necessarily sane. There are also many people who have lost their jobs during the current economic crisis regardless of their skill level. But these two examples demonstrate to us that unintended consequences of grand schemes and even the boundaries of sanity can move much faster than we would anticipate.
The first mortgage backed security was issued by Ginne Mae in 1970. This level of abstraction in our financial system is only 40 years old. Since then we have created a world-wide belief system that has a fairly unique attribute – no one really understands it. What is apparent is that the expressed value of these financial instruments is larger than anyone can imagine and represents far more money than could ever be spent or invested. Non-financial people are beginning to wonder out loud what its utility is. Those who attempt to get their arms around what is going on suggest that the next crisis will involve commercial real estate and unfold over the next several years but we would all be wise to keep an open mind. What we believe and how the movement of the boundaries of what is considered sane is a very difficult thing to predict.

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