Tim Rayment's epic and fascinating story in the Sunday Times on AIG and Joseph Cassano, the derivatives trader blamed for crashing the global economy, has the feel of a book shrunk to fit in a smaller space than might be wise or prudent. When a single paragraph ranges from former AIG CEO Hang Greenberg to Isaac Newton and back again, with references to iPods, Bloomberg terminals and 4x4 SUVs thrown in for good measure, it's easy to get dizzy.
But Greenberg faced a problem. Insurance is not like iPods, where if you invent the market, growth comes fast. Over time, it performs in line with the economy. In 1987 he found an answer: AIG would enter a joint venture with Howard Sosin, a pioneer in the new "Frankenfinance" of derivatives trading. You can thank Sir Isaac Newton for Frankenfinance. By showing in the 17th century that the universe conforms to natural laws, he encouraged our age to see money as a branch of physics. Starting in 1952, two generations of economists worked to show that people are like molecules, whose behavior can be predicted in ways that are stable over time. Science then infected everything, from how much capital banks need to protect themselves against insolvency, to the risk in credit-default swaps. But there was a flaw: the City's faux physicists never go back far enough in their analysis, because the data on the Bloomberg terminal cover a tiny period of history. "Real scientists tend to be much more sskeptical about their data and their models," says William Janeway, an MD of the private-equity firm Warburg Pincus and a Cambridge University lecturer. "They had all of the maths, but none of the instincts of good scientists." There is also the 4x4 effect: if you give people a safer car (read, a safer world through financial innovation), they tend to drive faster. But we are getting ahead of ourselves.
This is what is known in the blogging trade as "a must read." There are new details concerning AIG's sorry saga, including a provocative connecting-of-the-dots between the instances of accounting fraud that forced Greenberg's resignation and Cassano's big bets on credit derivatives. There's also a bonus picture of Cassano in full road-biker gear, which is not what I was expecting to see when I followed a link to the story from the Big Picture.
Uh-oh, I thought. I've seen guys like Cassano out on the road, perched on their $7,000 bikes and living only to sneer as they pass by all other weaklings struggling up a 15 percent grade. Now I know: After the cycling Cassanos of the world finish their rides, having crushed all their imagined competitors into submission, they take a shower and start trading credit default swaps, with sneer intact.
As Rayment notes: This is their destiny!
Alpha males such as Cassano push at boundaries. You could say it is their evolutionary purpose. That is one reason we need governments, to protect us when male ambition reaches too far. But our governments were mesmerized by our bankers. "From 1973 to 1985," says Simon Johnson, a former chief economist at the IMF, "the financial sector never earned more than 16 percent of [US] corporate profits. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the post-war period. This decade, it reached 41 percent." The whole point of financial companies is to allocate your savings to those who can use the money best. If they are taking 41 percent of the profit in an economy, something is out of balance. These figures reveal an enormous transfer of wealth.
The transfer of wealth to the financial sector alpha males of the world is certainly a breakdown of government. But isn't it also a result of financial sector alpha males taking over the government? So when Rayment is writing that we need government to protect us from male ambition, doesn't he really mean that we need even more ambitious males to get into the ring and start swinging punches? Talk about your vicious cycles ...