Received from Helen

Good points, badly conveyed.

The author could slim this book down to half the size, and it would be much better for the editing. In particular, he could loose some of the self-aggrandising stories and back patting. And occasional duplication. The academic style doesn't help convey his message clearly. And some of his stories (ValuJet, and Chernobyl in particular) are extremely weak support for his arguments.

Good points:
* complexity leads to tighter coupling between asset classes and markets
* tighter coupling leads to contagion across markets when something goes badly wrong
* margin calls can cause prices to dive when positions are large
* when all players hold the same positions this can cause a vicious cycle of diving prices requiring more margin calls
* coarse (non locally optimal) behaviour can give better survivability for agents when it comes to unknown and unanticipated shocks. ( )

I read this book before the financial crisis hit its peak, and it was astounding. Even for a non-finance person like me, the explanation of the workings of the financial markets and structured products was easily understandable, and the predictions of the market reaction to over-leveraging due to structured products, combined with a lack of liquidity proved prescient.
If you want to learn about the workings of the financial markets and how structured products work, and how both can fail, this book is for you, whether you are an expert in the field or not. ( )

Today’s financial derivatives, designed to control risk, have only succeeded in intensifying it.

The author, Richard Bookstaber, a Wall Street quant, makes a simple point. Although economic growth is more stable today than it has in the past 50 years, the markets have grown more volatile. A MIT-educated mathematician was lured out of academia to create complex financial instruments and computer models designed to limit risk. In his own words, he failed.

Yet that does not lessen his insight. The author paints as poignant a picture of the 1987 Crash and Long Term Capital Management (LTCM) failure as I have read. In the latter case, he argues convincingly that LTCM demise began not with the Russian default, but with Sandy Weill’s decision to shutter the newly acquired U. S. fixed income arb desk of Solomon Brothers,

As great as his historical analysis is, Bookstabler’s book appears to lose focus when stipulating solutions. The author admits it took him more than a decade to complete this book. That comes as no surprise. Complex situations defy Euclidian precision.

His prescription of reduced complexity and coupling with less leverage seems, somehow, unlikely. Neo-classical economics with its efficient markets assumption does not jibe with today’s instantaneous distribution of copious amounts of information. Until human beings adapt, volatility promises to increase.

Penned by the Pointed Pundit
December 9, 2007
3:51:11 PM ( )

I'm adding to my review and upgrading my rating from 3 to 4 stars. The complexity that worried Bookstaber is, by common consensus, at the heart of the current credit crises. Give him high marks for his perspicacity. At the time his book was published, the Wall Street Journal noted that things had changed since the time of the "problems" Bookstaber wrote about, and they were extremely unlikely to occur again. And the Maginot Line award goes to: The Wall Street Journal! I still fault Bookstaber for his naiveté. But, I think Bookstaber the starting point for the ordinary person interested in the current problems plaguing the capital markets. I would encourage them to go on to [[Steinherr]] Derivatives: The Wild Beast of Finance].

Original Review: An interesting mix of Wall Street gossip and "I was there" insight. He thesis is that complexity and "tight coupling" (as to which see p. 154) make for disaster. His prescription is less leverage and simpler financial instruments has a naiveté not befitting a Wall Street veteran. The wheel, having ratcheted, cannot turn back. Much better, I think, is [[Steinherr]], [Derivatives: The Wild Beast of Finance]. It, unlike [A Demon of Our Own Design], has intellectual heft. As General Manager of the European Bank,[[Steinherr]], provides "I was there" treatment of financial calamities that are more important in the debate about the role of derivatives and questions about regulation. His coverage is much broader without losing focus. Indeed, one can ask, does the loss of Solomon Brothers or pre-merge UBS or any of the number of banking houses that have managed to do themselves in, really have any global (ontological) significance? To ask the question about [[Steinherr]]'s examples (Metallgesellschaft, Bankers Trust, Orange County) is to answer it: yes. ( )