| A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation |  | Author: Richard Bookstaber
Publisher: Wiley
Category: Book
List Price: $16.95
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Rating:  68 reviews
Sales Rank: 189,119
Media: Paperback
Pages: 304
Number Of Items: 1
Shipping Weight (lbs): 0.8
Dimensions (in): 8.9 x 5.9 x 0.9
ISBN: 0470393750
Dewey Decimal Number: 332
EAN: 9780470393758
ASIN: 0470393750
Publication Date: December 10, 2008
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Product Description
Inside markets, innovation, and risk Why do markets keep crashing and why are financial crises greater than ever before? As the risk manager to some of the leading firms on Wall Street–from Morgan Stanley to Salomon and Citigroup–and a member of some of the world’s largest hedge funds, from Moore Capital to Ziff Brothers and FrontPoint Partners, Rick Bookstaber has seen the ghost inside the machine and vividly shows us a world that is even riskier than we think. The very things done to make markets safer, have, in fact, created a world that is far more dangerous. From the 1987 crash to Citigroup closing the Salomon Arb unit, from staggering losses at UBS to the demise of Long-Term Capital Management, Bookstaber gives readers a front row seat to the management decisions made by some of the most powerful financial figures in the world that led to catastrophe, and describes the impact of his own activities on markets and market crashes. Much of the innovation of the last 30 years has wreaked havoc on the markets and cost trillions of dollars. A Demon of Our Own Design tells the story of man’s attempt to manage market risk and what it has wrought. In the process of showing what we have done, Bookstaber shines a light on what the future holds for a world where capital and power have moved from Wall Street institutions to elite and highly leveraged hedge funds.
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Showing reviews 1-5 of 68
The Problem is Complexity and Leverage May 1, 2010
Mr. Stephen N. Driscoll (Sydney, Australia)
1 out of 2 found this review helpful
The book takes wind from one particularly powerful early paragraph,
'In spite of forty years of progress and a drop in real economic risk by 50% or more, the average annual standard deviation in the S&P500 index was higher during the past 20 years than it was 50 years earlier. Risk should be diminishing, but it isn't.'
In addressing this conundrum the book dwells upon the issue of liquidity.
Bookstaber outright states that the principal force moving market prices on a day-to-day basis is not new information, it is liquidity. He raises two main points from this:
Liquidity problems occur because of continuous reporting. A business with frequent disclosure may be forced by its debtors into bankruptcy, despite having solid assets, as the market falls. Leveraged businesses will in this regard always be at the mercy of the occasional irrationality of market pricing.
Furthermore, in a liquidity crisis the correlation between growth assets will move towards one. Bookstaber discusses the example of the Hunt Brothers - major investors in silver and cattle. A collapse in silver prices forced the brothers to sell silver and cattle to meet margin. This led to a collapse in cattle prices (oversupply lowers prices). The take home message - when it comes to risk management during a crisis, usual market relationships are not as important as who owns what, and who needs to sell. But how can a risk manager attain this information? As such, quite unpredictable forces that impact asset prices can force even a good business into bankruptcy.
He broadens his scope, emphasising the inherent unpredictability of many market outcomes. The Heisenberg Uncertainty Principle is discussed to show that no event can ever be truly observed, without the observation of that event distorting the event itself. Even if the actions of all market participants were fully disclosed, instantaneously, and for all observers, this disclosure would so modify participant behaviour that the markets would be irrevocably altered.
He then discusses the Edward Lorenz Butterfly Effect. Slight differences in initial inputs to non-linear systems can lead to wildly divergent end outcomes. The classic example is the statement by Lorenz that, `One meteorologist remarked that if the theory were correct, one flap of a seagull's wings could change the course of weather forever.' Bookstaber suggests that the financial markets are of similar complexity to the global weather system. As such, specific predictions of even extreme precision are vulnerable to wildly missing their medium term mark.
And so, by this stage, he seems to have dismissed the modern practise of risk management. If markets are to a large part moved by low predictability liquidity events, that cannot be observed without interaction, and are subject to the wildly diverse end outcomes of a complex non-linear system, then how can an individual or company maintain reasonable control of their risk exposure?
He suggests that companies must more closely resemble cockroaches. Cockroaches are incredibly simple creatures. Yet they have demonstrated an ability to survive across an extraordinary length of time, in a spectrum of climates.
Bookstaber suggests that many financial sector firms over-adapt with extreme specificity to the problems that they can identify, piling on leverage and complexity within the limits of their observed risks, and in so doing permitting inordinate vulnerability to the unexpected. Like many extinct species that were fine-tuned to optimisation within their surroundings, they are vulnerable to the situation changing.
The answer is robustness. It is the reason that the cockroach has outlasted a plethora of seemingly stronger creatures. The answer, the author concludes, is less complexity and less leverage.
I absolutely agree with his conclusions. They are almost obvious. World financial systems will operate more efficiently in the long term if they are less leveraged and less complex.
Now it is up to the regulators to enforce a more appropriate use of derivates, and a reduction in gearing.
 Still on shelf.... March 10, 2010
The Shepherd (Kalifornia)
1 out of 7 found this review helpful
I have started this book a couple of times... not really into it. Wrote this review to get it out of my review page.
May be very good, may be very bad... no opinion really except it has not grabbed me yet!
 Informative February 14, 2010
Brandon J. Downing (Cincinnati, OH)
2 out of 4 found this review helpful
This book attempts to describe the mechanics of the previous financial meltdowns. Very advanced even for those with a finance background but takes time to elaborate on specifics. Good read for applying previous applications to future problems when they do occur.
Don't Blame Us- You Guys Did It Yourselves December 25, 2009
Linksman (Pinehurst, NC)
2 out of 4 found this review helpful
This is an excellent book by a literate and intelligent and experienced market participant with impeccable credentials. It explains how complexity and interconnectedness of financial markets makes them failure prone, and it makes two excellent suggestions: reduce leverage and limit complexity of financial instruments. I recommend the book wholeheartedly, yet I cannot help feeling it largely misses a more important point.
We now inhabit a world of nearly infinite electronic money most of which serves no purpose but to undertake repeated financial transactions in the expectation of small returns. The results are of no importance to more than 90% of the population, except when they provoke financial catastrophe for those who must work to live. The results are at best a headache for over ninety percent of the remaining ten percent, who have somehow managed, defying all odds, to accumulate a modest competence subjecting them unavoidably to the world of `investments.'
Financial catastrophes and toxic investment markets are things we cannot afford as a democratic republic, even if they continue serving the financial interests of bankers, corporate poobahs, hedge fund managers, academic charlatans and politicians on the take. We tolerate banks because they lubricate the real economy by making productive loans, or at least they used to do so. We provide tax loopholes for hedge funds and the excuse is they provide liquidity for our financial markets, except when they do not. We encourage managers of public corporations to justify obscene compensation schemes amounting to looting operations on the theory that the executives are somehow responsible for corporate success. Failure apparently just happens.
A very few simple reforms would go far to resolve all our systemic problems. Reinstatement of Glass Stegall, a tax on financial transactions, prohibitions on gambling by institutions affected by a public interest, rational limits on executive options and compensation, progressive taxation of outlandish incomes. Let the investment banks and the hedge funds continue gambling on toxic derivative contracts, and pay a transaction tax with each roll of the dice. Prohibit derivative gambling by custodians of other people's money: banks, pension funds, insurance companies, public corporations, mutual funds, municipalities. No doubt the investment banks and the hedge funds will soon devour one another, inasmuch as trading is a zero sum game. Who cares? On the transaction tax money alone, the rest of the country can rebuild America
 Confused and boring November 29, 2009
Ratatosk (Europe)
3 out of 6 found this review helpful
Large parts of this book are anecdotes from Wall Street about people you have never heard about and will never care about. Entire sections of the book seem to be sort of an auto-biography of the author's professional life and the people he has met whilst on the job. It seems rather self-indulgent of the author to assume the readers are interested in this (he even tells us where he does Jiu-Jitsu ...) Other parts of the book are loose comparisons of financial markets to things such as nuclear power plants, or tales about the tulip mania in Holland and the non-liquidity of medieval England. The author also has a tendency to repeat himself several times within the same page and it gets quite annoying to read everything phrased three slightly different ways.
When the book finally comes around to discussing trading and quant strategies it assumes the reader is already a quant and knows the meaning of even the more obscure terms which are never explained.
The very last line of the conclusion is 'simpler financial instruments and less leverage will create a market that is more robust and survivable.' This is apparently only a surprise to people in finance.
Overall this is a confused and often boring patchwork of a book (sorry to be so harsh.) There are a couple of interesting bits here and there, but you have to dig for so long to find them that it's hardly worth it.
Showing reviews 1-5 of 68
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