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A Cautionary Tale

F.I.A.S.C.O: Blood in the Water On Wall Street
Frank Partnoy. W.W. Norton & Co. 288 pages; ISBN: 0393046222; $25.00; hardcover.

Reviewed by Satyajit Das

F.I.A.S.C.O. is a kiss-and-tell book, or, in the new Wall Street tradition, a trade-and-tell or a sell-and-tell story. Frank Partnoy worked in Morgan Stanley's derivatives products group in 1994–95, and presents in this book a diary of his experiences in the world of derivatives sales, particularly emerging markets derivative sales. The book has its antecedents in Michael Lewis' Liar's Poker and, to a lesser extent, Po Bronson's (more fictionalized) Bombardiers.

The book stays true to the classic formula:

1. Arcane finance. Identify a subject matter that the average reader has vaguely heard about and would like greater knowledge of but only in the form of single-syllable words, preferably in baseball-card-size chunks. Partnoy's descriptions of derivatives products using analogies to Corvettes are of this type.

2. Character assassination. Pick a number of (preferably well-known) individuals and do a splendid hatchet job on them. In this regard, Bidyut Sen and Marshall Salant, two high-ranking Morgan Stanley managing directors, are the named targets. Two lesser targets, identified only as the Queen and the Scarecrow, are the unidentified targets. Endless railings about their antics and behavior are to be found in F.I.A.S.C.O. Unfortunately, the derivatives characters targeted are neither as immediately interesting nor their antics nearly as reprehensible as the author—with excessive hyperbole—tries to make them. They come across as the type of egotistic, driven individuals who frequently dot corporate life. Certainly, there is no Guttenfreund, Merriwether or Rainieri in this book. To some extent, this robs the book of the drama of Liar's Poker.

3. Zillion dollar figures. Flaunt large numbers at every opportunity to give the book the appearance of world-shattering significance. The reality is that derivatives and finance generally are boring to most people and the size of the figures are not readily comprehensible to even the principle actors, so the impact is marginal. As one of the characters in the book says, it's the game.

4. Lifestyles of the rich and famous. Throw in some vignettes of excesses of corporate lifestyle, preferably with some sexual titillation (in this case, tales of women in tight skirts and one woman's description of her skills at fellatio) to convey the image of some dark evil empire. Unfortunately, at best the atmosphere is that of seedy, beer-sodden college fraternity gatherings and college male fantasies.

5. "I could have been a contender” tales. Add some example of how the author was a principal creator/actor in major transactions but credit was taken by his or her boss. Unfortunately, in corporate life generally, success attracts paternity suits while failure tends to remain an orphan.

6. Moral righteousness/ indignation. Layer a tone of smoldering indignation, moral angst and other elements of righteousness in which the author/principal character sees the error of his or her ways and turns his back on the evil world of commerce (and millions of bucks) to reveal to the world the sickness he or she has seen.

All in all, the formula is little changed from that of Huckleberry Finn's journey of self-discovery. Unfortunately, Mark Twain's skill and considerable insight are not present.

All that notwithstanding, F.I.A.S.C.O. is a light, frothy and not unpleasant read. While there is little new here, the author basically rehashes a number of celebrated derivatives disasters (Procter & Gamble, Orange County, Barings and so on), and the book is reasonably faithful to the era it sets out to document.

Stripped of the hyperbole, the book provides the reader with some insight into the worst excesses of the derivatives business in the early 1990s—albeit fairly narrowly focused and with evident bias. The most interesting concerns raised by the author (some of which this reviewer incidentally shares, at least in part) includes the remuneration practices and high-bonus orientation that drive questionable sales practices. (The Bank of England earlier this year aired its concerns about the excessive focus on bonuses and its impact on risk taking and sales behavior.) The author also focuses considerable attention on the cozy relationship between the creators of financial products and the credit rating agencies that rate these structures. There is little new here and a number of financial economists have identified these problems for years.

The book's arguments on a number of other issues are much more difficult to defend, however. The first is a proposition that derivatives are a pure zero-sum game. Derivatives transactions can be called a win/lose game only if the underlying exposures of the actors are ignored. The author dismisses the legitimate function of derivatives in transferring risk and replicating exposure to particular asset price moves efficiently. The vast majority of derivative transactions are entered into for these reasons, but these are ignored and the book, as a result, tends to give a distorted view of derivatives and their role.

The author repeatedly argues that the transactions depicted in the book are basically rip-offs—that Morgan Stanley made huge profits without taking any risks. In reality, the construction of the hedges of these structures is neither inexpensive nor without risk. An indirect way of supporting this contention is to consider the large losses suffered by banks and broker-dealers in derivatives. The author also gives no real explanation of his proposition that repackaged asset vehicles are less objectionable than structured notes.

The idea most likely to be challenged is the central proposition of the book: The authors sees the world of investors as one of cheaters (who use derivatives to circumvent investment restrictions) and widows and orphans (gullible investors led unsuspectingly to the doom of derivatives oblivion by rapacious salespeople). This analogy is fundamentally flawed when one considers that the list of widows and orphans includes almost every major fund manager in the world. In short, if the investor is of equal power, then it is unclear, at least to the reviewer, how one should go about protecting these large and powerful investors from themselves.

The key issue here is that of disclosure of the terms of the deal. It is here that the author's case is weakest. F.I.A.S.C.O. gives little evidence that the investors were in fact mislead by deliberately withholding or altering information. One particular exchange is telling—a salesperson inquires whether the investor would like him to go over the details of the transaction and is told in no uncertain terms that it is not necessary.

There is no doubt, in this reviewer's opinion, that excesses in sales practices exist. They are, however, equaled by the arrogance and feigned knowledge of a few investors who—motivated by the pressure to meet aggressive investment return targets and the constant grinding quarterly measurement of performance against an index—take on excessive risk. Given that this is the case, I am not sure it is only the derivatives broker dealers are to blame. If anything, F.I.A.S.C.O. is a cautionary tale of the lack of expertise of the buy side in some cases as much as it is about unsavory sales practices.

Stripped of the hyperbole, the book provides the reader with some insight into the worst excesses of the derivatives business in the early 1990s—albeit fairly narrowly focused and with evident bias.

The step in logic which then dictates an implicit call for increased regulation of derivatives activity to control derivatives sales practices is even more problematic. This assumes a regulatory void. There are various legislative and regulatory provisions in the United States and other jurisdictions that regulate derivatives activity and, increasingly, disclosure of information about more aggressive derivatives structures and sales practices. It is not clear that additional regulations would necessarily address the excesses the author is concerned about. The case for and against regulation of derivatives has been extensively debated and the broad conclusion appears to have been against specific legislation in view of the fact that the existing regulatory structure was considered to provide adequate supervision of such activities. Certainly, the author does not make a compelling case that would dictate a revision of those earlier conclusions.

In reality, F.I.A.S.C.O. is an interesting period piece—a vignette of Wall Street life—with all the absurdities and contradictions that it embodies. The book records fairly faithfully the excesses of a specific period but in reality does not in any serious manner make a case either against derivatives or for increased regulation of such activity. It takes a time-honored American literary tradition—the coming-of-age book—and places it in a new setting: Wall Street. It does not have Huck Finn's profound insights about life, but then again, Huck didn't sell derivatives and the author is no Mark Twain.

Satyajit Das is an independent derivatives consultant based in Sydney, Australia. The author of four seminal derivatives works, he served as the treasurer of the TNT Group of Australia, and has worked in various capacities at Commonwealth Bank of Australia, Citicorp and Merrill Lynch Capital Markets.