November 12, 2007
Conglomerate Books: FIASCO and Derivatives Trading: Setting the Scene
Posted by David Zaring

After graduating from Yale Law School, Frank Partnoy took two jobs as a derivatives trader, first with First Boston, and then with Morgan Stanley. FIASCO, published ten years ago, documents his experiences. It’s a story of disillusionment about a business that Frank comes to believe is rotten both in what it permits clients to do, and in how it permits banks to serve clients. On the client side, derivatives look like little more than either poorly understood gambling, or, at best, accounting legerdemain. But for banks, the incentives are more clear: the traders are urged  to “go kill someone” because there’s “blood in the water,” and to “rip their faces off.” The “their” and the “blood” are/belong to the clients, and as for the traders, they come across as none too smart, terribly petulant, and no fun to be around.

But FIASCO offers the readers more than simply this bleak bottom line. It begins with a cogent overview of how the derivatives business works, explains the roles traders played in that business, and goes step by step through the creation and sale of some of the derivatives that Frank dealt with during his time at Morgan Stanley. The book culminates in a trip to Japan, where collapsing Japanese financial institutions eagerly seize on Morgan Stanley’s exotic new products to move liabilities off their balance sheets just before the quarterly reports are due. In the end, Morgan Stanley gets rich, the Japanese banks get dishonest, and everybody else, it seems, loses. Frank concludes the book when he returns from Japan, quits his job, and moves happily ever after to the world of corporate legal practice in DC and, eventually, legal scholarship in San Diego.

Ten years, later, derivatives are going south on the banks again, and it’s worth thinking about what FIASCO has to say about it. Back then, the derivatives business seemed to be all about currency hedging (to the extent it wasn’t about moving liabilities off books); now, it’s mortgages. Back then, Morgan Stanley was managed by people more notable for their tempers than their understanding of exotic financial instruments. Today, Citigroup and Merrill Lynch (maybe Bear Stearns will be next) have rid themselves of tempestuous CEOs seemingly addicted to golf.  Are there meaningful parallels that can be drawn? Would Frank like to be able to rethink any of the conclusions he drew in 1997 in light of what has happened since then (fortunes made, markets grown, and so on)?

That’s what we’d like to find out. So if this post is the scene setter, in the next post, so Frank doesn’t think he has it too easy, we’ll reprint a couple a couple of the critics of his “excellent kiss-and-tell tale” (that’s the NYT) and “blistering indictment,” (that’s JIS).

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