The Young and the Reckless

Is it smart to be stupid?

Are the incentives in trading and financial markets so skewed that it’s profitable to be foolish and reckless? It sure seems so. One of the frequent targets of financial reformers is proprietary trading—the infamous “prop desk.” At this work-station, young men and women stare at multi-screen monitors all day, divining relationships between volatility, forward rates, overseas markets, and other traders. The goal is to get 15 seconds to 15 days ahead of the next trend, and ride it to a profit.

The pay-structure at the big banks and hedge funds creates a moral quagmire. Traders earn a base salary, enough to live comfortably in a big city. But they also receive an annual bonus, typically 10-15% of their trading profits. Have a good year, and that bonus can total tens of millions of dollars. Have a bad year, and you may not get a bonus. You may even get fired. But you never have to pay back your prior earnings.

The problem is the asymmetry: win big and you can get fabulously wealthy; lose big and go home and look for a new job. And it’s a pretty simple system to “game”: start small, build credibility, and get your trading limits expanded. Then bet big–really, really big. If you win, you may just have earned enough to fund a lavish retirement, your children’s and grandchildren’s college education, and a new hospital wing in your name. Lose, and—perversely—you may have gained enough credibility to start your own hedge fund.

Wall Street is littered with traders who have blown up their employers, their clients, and much of the financial landscape. As long as traders can just walk away from huge losses, they’ll just keep blowing things up.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2017-07-17T12:34:42+00:00February 28th, 2013|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

Leave A Comment