Emotional Finance

Lions and lion-shaped bushes in financial markets: traders’ expertise in emotion regulation

6 March, 201330 March, 2022 Mark Fenton-O'CreevyLeave a comment

Fight or flight Imagine you are one of our hunter-gatherer ancestors, walking across the African plains. Or perhaps, in more recent times a Massai tribesman in Kenya. The grass is long in places and punctuated by small trees and bushes. You are carrying no more than a long pointed stick to protect you from dangerous… Continue reading Lions and lion-shaped bushes in financial markets: traders’ expertise in emotion regulation

On the false contrast between rationality and emotion

Featured Mark Fenton-O'Creevy10 Comments

It is common to contrast emotions with rationality (usually in tandem with proclaiming the superiority of reason over emotion). Take for example this post on the changingminds blog. It is also the claim at the heart of Ayn Rand's morally barren apologia for the extremes of modern capitalism, 'Atlas Shrugged'. In this book she claims… Continue reading On the false contrast between rationality and emotion

Welcome to the emotional finance blog

Featured Mark Fenton-O'Creevy2 Comments

Money fractures marriages, drives wars, inspires art, motivates some people to great achievements, leads others to despair. Fear, desire, love, hate, jealousy, anger, anxiety, relief, shame and many more shades of emotion may attach to money in the course of an ordinary day. (Photo credit: @Doug88888)Yet, economic accounts of human financial behaviour focus on reasoned… Continue reading Welcome to the emotional finance blog

LIBOR, rogue traders and the supply of motivated offenders

Featured Mark Fenton-O'Creevy10 Comments

A brief trawl of media comment on the banking industry over the last few years suggests that the industry is awash with criminals and fraudsters. The picture of traders, often presented in the press, is of amoral risk-takers with bosses who are always ready to turn a blind eye if profits are being made. There… Continue reading LIBOR, rogue traders and the supply of motivated offenders

10 responses to “LIBOR, rogue traders and the supply of motivated offenders”

Scams victims and and Scammers | Emotional Finance

25 February, 2016

[…] There are important parallels between the traits that make many of us easily deceived by fraud and those that make traders in financial markets easily deceived by market movements. In my own research on the behaviour of traders in investment banks, I found these well educated, intelligent and highly trained professionals to be often prone to illusions about the extent to which they were in control and able to make unbiased financial judgements. Fear, greed and the need to maintain self-esteem may make many of us more easily trapped by a telephone or internet scam, but they also account for some major mishaps in financial markets. In another blog post I discuss some of the reasons traders may turn to fraud themselves. […]

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Mark Fenton-O'Creevy

25 March, 2013

Hi Steven, thanks for your feedback and for the really interesting comments.

I do know some remarkably effective and thoughtful managers in trading rooms, but I agree that this is by no means the norm. It is certainly the case that technical skill does not by any means always translate into effective management.

I wonder if sometimes the levels at which traders are being paid mean that there is a mutual interest between them and the bank in maintaining the illusion that they have no further development needs. Of course the more rational approach might be to ensure that trader managers have all the support they need to deliver the performance from themselves and their team that their pay justifies.

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1. Steven Goldstein
  
  25 March, 2013
  
  It is very interesting point you make. – I think part of the problem is that traders live in a bubble, many of them get paid well in excess of what managers in other parts of the bank get paid, their pay structure means that their P&L and any other contributing factors to their pay (such a rating from clients and sales) are paramount. – In a sense this is conditioning, they have no obligation to the organisation or wider business, and do not think in terms of business or strategically. I think this is understandable in this context.
  
  I had a conversation recently with the global head of trading at a major investment bank, he told me that the previous year they planned to put a number of trading managers on a two day management course, the reaction was derision from those who were selected. – They did not see the relevance, nor I guess wanted to be away from the business of trading. – I think this highlights the point well.
  
  Until banks start aligning their incentive structures, encourage a more corporate culture within trading businesses, and providing support and training, then this is likely to contribute.
  
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Steven Goldstein

25 March, 2013

Hi Mark

Wonderful piece as usual.

Having worked in trading departments of banks as a trader, I can vouch for the dreadful quality of bank management. This is not to say that these individuals are not well meaning individuals with high moral values, most of them in my opinion are. It is just that few if any have any management trading, or a sufficiently developed and full understanding of the big picture. Often they are grounded in the technical aspects of the job, and even then their experience will gravitate to their own particular field of expertise. I have seen the disastrous levels this has had at a micro level let alone from the macro perspective which fosters the situation which lead to examples such as the Libor fiasco.

Hans’s comment above illustrate this nicely. However, I will echo an example which affected a good friend and ex-colleague of mine at a major bank. The incident happened a few years ago before the GFC. The trader was involved in relative value trading across fx and interest rate spot and derivative products in a number of Asian currencies. He maintained a relatively flat book with regard to outright rate and fx exposure, however he maintained a high level of basis ‘cross market and product’ risk. This meant the bank managing his risk across various different systems, where end of day valuations and risk metrics varied. As such his P&L and Risk assessment was open to a variation, and would differ significantly with his own records, maintained via spreadsheet. – The risk managers did not really understand his approach/method, the head of trading, also did not really understand his approach/method, which differed significantly from his own experience. The traders attempts to explain his approach typically fell upon deaf ears, as this would mean exposing potential ‘knowledge gaps’ of senior managers, plus over time his own numbers would prove correct (pretty much), hence he was given the necessary lattitude, ‘but’ was never really trusted.

One year the trader was on vacation, and out of touch. – There was a ‘short-term’ dislocation in the market, and his end of day P&L showed a large discrepancy, equivalent to the traders P&L for the first 6 months of that year. – This is where the risk managers and head of trading’s ‘lack of knowledge’ and ‘distrust’ became an issue. The Head of Trading, when presented with this from took a decision to liquidate the portfolio, a horrendous decision, as the portfolio unwind, cost more than 3 times the original loss. – In actual fact the dislocation merely exposed the mis-pricing between two different systems, and the traders portfolio would have been unaffected. – The trader was dismissed soon after his return.

The an example I have witnessed too many times over the years. – I now work as an executive and performance coach in the financial markets. – I am seeing these problems from the other sides. – MDs are often promoted from within the trading division, often though not always they are given 1 to 2 days rudimentary management training, in some cases a week. – They are completely ill-equipped for the task, and many of them become swamped. – These individuals are often technically skilled, but have little or no management expertise, and rarely any real ‘Strategic’ experience beyond their own trading experience. – There are exceptions, some make the leap superbly, but these are few and far between, and even then they are rarely given the necessary support and training to turn this to the businesses advantage. – Steep hierarchies, and rapidly changes in management with people bringing in their own teams, often adds to the problems. – It is not surprise that businesses which keep a degree of continuity, provide adequate management training and support, have a strong ethical culture, or relatively flat and open management structures tend to be far more successful and suffer from less failings.

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Frank Thornton

17 March, 2013

An interesting detailed explanation but what is the solution to the problem?
The main point I noticed was that the enterprises involved were not broken down into manageable elements, it seems to me that most problems can be managed or controlled by forming them into manageable bites. Control over 75 to 85% of the actions and the remainder to be closely managed in small groups could be an acceptable solution. Regular overviews and highlighting of those actions that come over or below the median norm. This may seem a simple solution but then most smart solutions are. Trying to understand the emotions involved is interesting but I can’t see how you could manage that, as said, the people involved are of a large cross section of the population types, surely preventing this happening again by loose control and identifying risks would be acceptable. Again probably only 75 to 85% identification but much better than where we seem to be. Don’t try for 100% before you do anything, or you’ll never be in a position to implement some form of risk control. As a manager you do not have to understand every process in detail to manage it.
It seems, no thought was given to agree any rules, limits on expenditure without some limited consultation [the guy next door desk] in a group of 5 it wouldn’t be too difficult to converse?
I trusted my guys and gals, but encouraged them to keep me in the loop, so I could support them if they got into difficulty and it gave me the opportunity to contribute and keep watch.
As the Americans say, ‘It happen on my watch’, but it means you, as a manager, are supposed to ‘watch’.
Sorry, but surely that is the main function of senior managers, to watch-out for risks to their company.

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1. Mark Fenton-O'Creevy
  
  17 March, 2013
  
  Thanks for the feedback Frank. We seem to agree that good line management is important. I do though think that managing the emotional agenda is an important management skill.
  
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  1. Frank Thornton
    
    18 March, 2013
    
    I agree, but from my experience good line management of emotional elements can only be done by fairly close involvement, i.e. small teams with close contact, it seems we agree that we can’t eliminate extreme emotions, so we must, to some extent, recognise and control the extreme extents. Often these emotions come from outside the workplace.
    
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AnyaWorkSmart

5 March, 2013

Very good points! Especially about the gap in how traders are being perceived by others. I know personally a number of traders, and what I have noticed is that because they understand the volatility of market they are actually more risk averse than many others.
Thank you for interesting post Mark!

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Hanns G Heiliger

24 February, 2013

Finally a useful and well focused analysis.
A short background for myself: Retired after 40 years in International Bank Operations and Financial Risk Management, I was – responsible for International Operations at the EABs – strongly involved in the denouement of Herstatt, integration of Franklin National’s International Operations into EAB, merging the branch of Societe Generale France into EAB, moving EABs international l operations off-shore, running risk management of EAB globally in New York, and running the US Treasury and the related trading and risk management sector for Deutsche Bank North America. Ultimately, I ran the marketing and sales activities of Wall Street Systems, a trading/risk management software that provided cross asset class straight-through processing for Financial Institutions and International Corporations. I ran the trading room of EAB and DB North America for several years.
Here is the summation of my analysis:
I completely agree with your findings regarding traders and trader mentality. The fundamental component of attitude and behavior lies in the fact that they are “risking” not their own wealth, but the money of an “unidentifiable” source, so that an emotional link is not established. The limit parameters are defined by the policies and behavior of the management supposedly controlling their activities. I remember during my trading days – in the late 1980s – , I got a phone call from the global head of treasury and trading a day after I had an unusually profitable day in trading. But, instead of being praised, I got a lecture on excessive trading profits, meaning excessive risk positions, and I was told to close the positions and not to follow the trade concept I had develop again. The effect on my bonus: $0. Such managerial perspectives are missing in the organizations that only have a profit orientation and are unable or unwilling to control major sectors of their organization’s activities. This is a major management flaw, and I am not sure if it can be resolved for the 25 or so TBTF financial organization. I consider them too big to manage.
One of the most frustrating aspects of the current bank bashing activities in the fact that they all seem to circle only around the numerous symptoms of a much deeper and serious aspect, that requires resolution before attacking the individual “incidences”. In a very broad brush, the problem started in the US in the early 70s, when the Money Market Accounts (MMAs) created by the investment banking community raised the funding cost of commercial banks substantially due to the resulting disintermediation of DDA balances – that paid no interest – to the MMAs, that paid interest in the range of 5%+ for accounts that fundamentally functioned like DDAs. The resulting drop in profitability in the commercial banking industry created credit downgrades of the banks (Citi, Chemical, etc.) that raised their funding cost to the point that enabled AAA rated corporations – the former “Prime” customer base for commercial banks – to fund themselves in the capital markets (CP, Notes, Bonds etc.) cheaper than the banks could. This resulted in a substantial deterioration of the credit quality of the loan portfolio of commercial banks, and the need to find alternative funding sources.
Simultaneously, the Eurodollar market – “created” in the 50s by the USSR placing its $ denominated assets with banks in London to avoid getting these assets frozen be the US Government – exploded through the creation of the Petrodollar. These funds were rather competitive compared to the domestic CP and Fed Fund markets. The Eurodollar market became one of the main funding source for large commercial banks, but did little to improve the shrinking margins and deteriorating credit quality of the bank’s books. The shift of commercial banks to activities of the Investment Banking industry was the result of the shrinking revenues caused by the disintermediation. Trading became a revenue mainstay in an industry that was ill prepared to cope with the idiosyncratic risks imbedded in these new and dynamically developing products. Because of exploding competition, new product development concentrated on more and more complex structures, which became less and less risk transparent, and turned into cross asset risk correlations that nobody is able to identify, quantify and manage anymore. I remember providing a risk management analysis of a $4 billion planned M&A transaction, that involved 23 separate legal entities and a combination of 53 transaction components, including Fixed & Floating Loans, Fixed & Floating Deposits, Preferred & Common Stock, CP, MTNs, Swaps, FX, Caps, Floors, Collars, Swaptions, Credit Derivatives, Premiums, etc. They included cross-default clauses and swaps, and obviously a number of covenants – FX, Interest Rate and liquidity related – that made this transaction a true financial Rube Goldberg structure. Nobody was able to asses correctly the cross-product effect of all risks, though the individual risk components of the individual products were identifiable and quantifiable. Upon raising my concerns about the risk issues and the complete lack of transparency , the comments were “We’ll take care of the risks, and transparency is not in the forefront of our concerns”. Fortunately for me, the transaction never materialized.
I remember Alan Greenspan’s comment during the 1986 Savings and Loan debacle here in the States that holds more true than ever today:
“We must guard against a situation in which the designers of financial strategies lack the experience to evaluate the attendant risks, and their experienced senior managers are too embarrassed to admit that they do not understand the new strategies”

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1. Mark Fenton-O'Creevy
  
  24 February, 2013
  
  Thanks Hanns
  
  That is a really interesting account of your experience. I think your point about senior management being too embarrassed to admit a lack of understanding is especially telling.
  
  Mark
  
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