The Economist - USA (2021-02-13)

(Antfer) #1

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-
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