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Codes of Finance

Codes of Finance: Engineering Derivatives in a Global Bank

Copyright Date: 2011
Pages: 304
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  • Book Info
    Codes of Finance
    Book Description:

    The financial industry's invention of complex products such as credit default swaps and other derivatives has been widely blamed for triggering the global financial crisis of 2008.Codes of Financetakes readers behind the scenes of the equity derivatives business at one of the world's leading investment banks before the crisis, providing a detailed firsthand account of the creation, marketing, selling, accounting, and management of these financial instruments--and of how they ultimately created havoc inside and outside the bank.

    Vincent Antonin Lépinay, a former employee of the bank, investigates the journey of a derivative through the bank's front, middle, and back offices. In the process, he provides a rare look at the strange world of quants, traders, salespeople, accountants, and others involved in a self-annihilating form of life in which securities designed by the bank eventually threaten its infrastructure. Throughout, he tries to understand the baffling languages of engineered financial products and the often-conflicting bodies of expertise that are mobilized to create them.

    Codes of Financehighlights the massive costs of investment banking's hubristic dream of manufacturing global financial services that derive their value from multiple economies across the world. Yet the book challenges simplistic condemnations of financial engineering by showing that derivation is the central operator of economic life--stretching far beyond the phenomenon of financial derivatives themselves.

    Essential reading for economic sociologists and financial economists, as well as for readers curious to decipher modern finance, this is the first serious study of the intellectual and organizational puzzles raised by the controversial products of contemporary financial engineering.

    eISBN: 978-1-4008-4046-5
    Subjects: Finance, Sociology

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
    (pp. vii-viii)
  4. PREFACE Financial Innovation from within the Bank
    (pp. ix-xxiv)
  5. PROLOGUE A Day in a Trader’s Life
    (pp. 1-5)

    Codes of Financeexamines a bank to reveal how financial operators and financial products coexist. This coexistence is tense because the bank deals with innovative products that yield unexpected reactions on unevenly charted markets. Because the designs of the financial products introduced here is coextensive to the lives of traders, engineers, and salespeople, these innovations are major protagonists and need to be fleshed out. How can we describe a world that is a patchwork of individuals, machines, and products? A series of sharp definitions up front is tempting, but would miss the crucial uncertainty surrounding many of the latest innovations...

  6. INTRODUCTION Questioning Finance
    (pp. 6-22)

    This book tells the story of a financial innovation from the inside. But one might legitimately ask: Do we really want another insider’s account? Are we not already paying a high price for having left insiders to organize financial markets at their convenience for too long? If financial operators acknowledge that they erred, then the accounts that they give of their inability to control a situation that went out of control are short of illuminating. Threatened as scapegoats of a major financial crisis, those who have attempted to articulate the failure of the financial system usually spend more time shifting...

  7. Part I From Models to Books

    • [Introduction]
      (pp. 23-28)

      We start our journey into financial engineering by scrutinizing the product. This close focus has one objective: understanding how the theoretical imaginings of financial engineers become financial services, which are then maintained by traders on actual Exchanges. The development of new products is one of the secret steps of market operations. The genesis of products is protected because that is where the know-how of the engineers shows itself the most clearly. For the bank to survive and attract new clients, new financial services must embody new possibilities for investors and their money. Banks are in a race against other financial...

    • CHAPTER 1 Thinking Financially and Exploring the Code
      (pp. 29-54)

      The trading room is a place where new financial products are created, sold, and maintained. This process might seem simple, at least in its fundamentals. It involves the purchase and sale of new and traditional products with the aim of guaranteeing the greatest income for the bank while minimizing the risk of losses. It turns out, however, that having even an approximate idea of the value of some of these products is not at all intuitive. Such is the payoffandrisk of financial innovations. Typically, clients and competitors do not know how to assess these products and find themselves...

    • CHAPTER 2 Hedging and Speculating with Portfolios
      (pp. 55-86)

      Securities are economic purifications (Latour, 1987)—vehicles that acquire a mobility and versatility not initially present in their underlyings. They capture nominal fractions of industries while protecting holders from some of the contingencies of these economies: with securities in hand, no manager is hassled. Here is the dream of capital made liquid and reversible for good: where wealthy investors are at long last protected from the future (they can sell whenever they anticipate a falling price) and from the spatial dispersion of industrial enterprises (they are worth their price through the Exchange, which is both central and detached from the...

  8. Part II Topography of a Secret Experiment

    • [Introduction]
      (pp. 87-90)

      The peculiar assembly line called forth by the CGP has nontrivial consequences on the organization of the bank and on its spaces. Secrecy rules around these activities in the trading room. The mode of value creation exploited by CGP engineers cannot suffer too much publicity, and the business model adopted there is one of derivative finance, whereby profits are extracted quickly before competition catches up and undoes the expertise differential initially created. What comes out of the assembly line reaches the clients and, through them, possible competitors, but the formal mode of hedging and the local recipes invented by the...

    • CHAPTER 3 The Trading Room as a Market
      (pp. 91-118)

      Traders are central pieces of the puzzle created by this financial experiment: they sit at the nexus of the financial markets, where they collect information, and the trading room, where they trade it. This business thrives on several forms of information. Each of these milieus in which the trader operates has its own rules and its own economy: experimentation with products on the market (research insights made “in the field”); elaborations led by the quantitative engineers and financial engineers (and confined to the trading room) about the product, the internal labor market, and the external labor market. Mastering the scenarios...

    • CHAPTER 4 The Memory of Banking
      (pp. 119-152)

      In this chapter, we travel to the bank’s back office to observe how products are stored.¹ From the perspective of the back office—not dissimilar to that of the front office—CGPs are disruptive: they impose themselves on a bank’s conservation methods and demand new rules. The challenge for the bank comes from its complex topography—itsinvagination, to borrow a physiology term used by the philosopher and historian of medicine, François Dagognet—as contacts with the outside world morph from being driven by the front office (salespeople, traders, engineers) to being the realm of the back-office managers.² This reversed...

  9. Part III Porous Banking:: Clients and Investors in Search of Accounts

    • [Introduction]
      (pp. 153-156)

      If the trading room mimics a laboratory by strictly controlling all the transactions taking place at its margins, the financial experiment still owes some of its features to outside factors. The last part ofCodes of Financepays attention to the interferences created by outside forces in this quasi-laboratory. The open communication required of the bank so far occurred exclusively through two channels: first, through the job market pumping new operators in and out, and second, through the Exchanges on which traders and their assistants would carry out hedging in the afternoon. But neither the job market nor the Exchanges...

    • CHAPTER 5 Selling Finance and the Promise of Contingency
      (pp. 157-181)

      From the complex topography of the bank observed in chapters 3 and 4, it became clear that salespeople were standing at a crucial juncture for the business of secrecy. Moving back and forth between clients and engineers, salespeople straddle an expensive borderland between that which is inside the bank and that which is outside. The main problem facing them as they shuttle back and forth between these two areas is therefore one of border control. As we have seen, even within its confines the bank is not unitary, and selling these complex products forces salespeople to negotiate the small but...

    • CHAPTER 6 The Costs of Price
      (pp. 182-203)

      The claim trumpeted by CGP salespeople is appealing to clients. It offers access to the worldwide economy through a payoff formula and—it seems—nothing more than a payoff formula. Farewell dusty and noisy economies. Farewell manufacturing plants and their recalcitrant workers. Enter the agile vehicle of modern capitalism: clean profit and controlled risks. Yet, this shift from physical capital to payoff is only one of the operations taking place in the bank. Accounting takes place simultaneously, and that other reduction is the direct consequence of the legal status of the bank, whose activities must be made public on a...

    • CHAPTER 7 Reverse Finance
      (pp. 204-221)

      In this chapter, I come back to the question of the nature of a financial firm and the strains generated therein by the design of financial products. Trapped between offering ever-innovative services through a chaotic and hardly accountable organization on the one hand, while on the other hand simultaneously delivering itself as a publicly traded company under the mode of securities, the bank tries to accommodate two incompatible gestures. The first imperative privileges the client to the extent that he or she does not need to worry too much about the process used by the engineers and traders. A client...

  10. CONCLUSION What Good Are Derivatives?
    (pp. 222-232)

    In conclusion to what has primarily been an ethnographic journey into General Bank with few forays outside of its walls, it is necessary to go back to one of its main protagonists to extract general insights about finance.¹ The CGP has been the organizing principle of this narrative. Tracking it closely has offered a glimpse of the bank rarely enjoyed by the previous ethnographers of finance, who have too often circumscribed their objects of study to either populations of the world of finance (Abolafia, 1996; Godechot, 2000; Ho, 2009) or to organizations (Baker, 1984). In doing so, they have not...

  11. APPENDIX A Capital Guarantee Product: The Full Prospectus
    (pp. 233-234)
  12. NOTES
    (pp. 235-264)
    (pp. 265-276)
  14. INDEX
    (pp. 277-280)