The Economist - USA (2021-02-13)

72 Finance & economics The Economist February 13th 2021

H

e nowrunsa chainofhotelsinhis

nativeGhana.Butinthe1990sTony

Yeboahplayedfootballata highlevel,his

twoseasonsatLeedsUnitedsandwiched

betweenlongerspellsintheBundesliga.

InEnglandheisfondlyrememberedfora

wonder-goalagainstWimbledonfc.

Watchit onYouTube.Trappinga high

ballexpertlyonhischest,hejuggles

betweendefendersbeforesmashingthe

balloffthecrossbarintothenet.

Greatgoalsstayinthemindlongafter

thegame-to-gamegrindofa champion-

shipwinfadesfrommemory.Soit is

withinvesting.Successoftencomes

downtothecompoundingofincre-

mentalgainsovertime.Thetradesthat

capturetheimagination,though,arethe

boldoneswithbigpayoffs.Amongthe

biggestandboldestwas“TheBigShort”,a

betagainstsubprimemortgagesbefore

the 2008 crash,andalsothetitleofa

bookbyMichaelLewis(and,later,a film).

Thatepisodefeelsrelevantagain.The

recentspectacularrun-upinstockprices

andtheattendantmaniainpocketsof

thefinancialmarketshavetheword

“bubble”onmanyinvestors’lips.A new

paper*byAaronBrownofNewYork

UniversityandRichardDeweyofRoyal

BridgeCapital,a hedgefund,re-exam-

inestheBigShortandsoundsa noteof

caution.Itarguesthatthebetagainst

subprimemortgageswasfarriskierthan

isoftenappreciated.Thepaperhasa

subtlermessage,too:thewayinwhicha

tradingideaisexpressedisasimportant

astheinsightthatunderpinsit.

Peoplewholivedthroughit can

scarcelyforgetthesubprimecrisis.Still,

here’sa recap.Inthemid-2000s,house

priceswererisingrapidlyinmanyrich

countries.InAmerica,muchofthe

growthinmortgagelendingwasto“sub-

prime”borrowerswithlowcreditscores.

Thesemortgageswerepooledandturned

intosecurities.Theriskiesttranchesof

thesepooledmortgagestookthefirst

losses,providinga bufferfortheaaa-rated

tranches.Suchwasthedemandforaaa

bondsthatstandardsslipped.Justabout

anyonecouldgeta subprimemortgage.

America’shousingboomhadallthe

hallmarksofa bubble:cheapmoney,a

build-upofdebtanda beliefthattherewas

norisk.Ifyouweresominded,howcould

youbetagainstit?A handfulofclever

peopleworkedoutthatsubprimebonds

werelikelytosuffera higherrateofde-

faultthanwassuggestedbytheirpriceor

creditrating.Sotheybetagainsttherisk-

iesttranchesoftheworstpools.They

enteredintoagreementswithbanks,

calledcredit-defaultswaps(cds), which

insuredspecificmortgagebondsagainst

default.In 2007 and2008,defaultrates

soared.Thecdsinsurancewastriggered.

Thepayoffwasasspectacularasa Tony

Yeboahgoal.

Whydidn’tmorepeoplebetthisway?

MrBrownandMrDeweyspoketoin-

vestorswhoconsideredtheshortsub-

primetrade,butpassedonit.Oneturn-

offwastheBigShort’ssteeplynegative

“costofcarry”:thepremiumoncds

insurancewashigh.Moreover,mortgage

cdswereilliquidinstruments,makingit

trickytogetoutofthetrade.A highcost

ofcarryisa bigbarwhenthepayday

mightbeyearsaway—ifit comesatall.

Thebanksthatwerethecounterparties

tothecdscouldbedraggedunder.May-

bethegovernmentwouldmakegoodall

mortgage-holderswhenthebustcame.

Historydidnotplayoutthisway.But

investorscouldnotbesureatthetime.

Tradersfoundotherwaystobet

againstthebubble.Onewastosidestep

thenegative-carryproblembybuying

riskytranchesofsubprimesecurities,

withdouble-digityields,andatthesame

timetakingoutinsuranceon“safe”aaa

tranchesusingcdswitha fairlylow

premium.Thebetherewasthata hous-

ingbustwouldblowupbothriskyand

safetranches;butwhilewaitingforthe

apocalypseyoucouldbenefitfromposi-

tivecarry.Perhapsthesafestwaytoprofit

froma bubbleisthepick-up-the-pieces

trade,inthiscasebuyingmortgage

bondsatfire-saleprices afterthebust.

A subtextoftheBrown-Deweypaper

isthatconvictioncanbeyourenemy.

Knowingforsurethatsomethingisvery

askewmaynotbeenoughtomakeyou

money.Still,theprecariousnessofthe

BigShortisa bigpartofitslegend.Yes,

thingsmighthaveplayedoutdifferently.

Andif TonyYeboah’sshotwereaninch

higher,thenit wouldnothavebeena

goal.Butit wasnota fluke.Hehadscored

anequallyspectaculargoalagainstLiver-

poola monthearlier.Thatonewentin

offthecrossbar,too.

ButtonwoodCrossbar challenge

LessonsinbettingagainstbubblesfromtheBigShort

..............................................................

* “Toil and Trouble: Don’t Get Burned Shorting

Bubbles”, February 2021.

banks are to raise capital on public mar-

kets—requires a strategic rethink that

“wartime” ceos have shown little will or

skill for. A growing chorus of pundits, in-

vestors and board members want fresh

faces to embrace the mission.

This is not to say that Europe’s bank

bosses are entrenched (save some excep-

tions: Frédéric Oudéa has run Société Gé-

nérale, a French lender, for 12 years). The

average boss at a big European bank has

been in post for four years, compared with

seven in America. Succession planning at

some banks, including Standard Char-

tered, is said to be under way. But the same

tired cast seems to be shuffled around. Of

the nine European banks that changed

chiefs in 2020, seven picked either a male

insider or a male banker from a local rival.

Andrea Orcel, chosen to lead UniCredit, an

Italian bank, last month, helped build it up

decades ago. Ralph Hamers, ubs’s new

boss, came from ing, a Dutch bank.

One problem is that the pool of candi-

dates is drying up. When Mary-Caroline

Tillman of Russell Reynolds Associates, a

headhunter, worked on bank ceosearches

ten years ago, her shortlists included 15-20

qualified candidates. Today she typically

finds five or six. A lot of industry stars are

now too old; a few others have lost their

sheen. Many suitable executives do not

want the top job, which comes with more

scrutiny from the press than elsewhere. It

is also less richly rewarded. Last year James

Gorman, who runs Morgan Stanley, an

American bank, was paid $33m. ingfaced

public criticism in 2018 when it proposed

raising Mr Hamers’s pay to €3m ($3.6m).

Recruiting outsiders is also hard. Aspir-

ing ceos must be vetted by European regu-

lators, implying a ton of banking experi-