In 2004 I did an internship in Deutsche Bank’s Credit Structuring team. It was an incredibly lucrative business, I remember listening in to a phone call with a big European defence agency who bought some structured assets and in the process, made the team of 4 guys I was working with (we were the Germany desk) quite a few million Euro in profit, for what seemed like not a lot of work.

I remember thinking something was weird, how a bunch of bonds that in aggregate didn’t pay much in interest, could be magically combined, and then sliced up, and out of nowhere, 200 or 300 basis points of profit would appear. Surely something to do with the ratings was being manipulated.

Anyway, the profits being made weren’t really profits, in that the ‘profit’ would accrue over the lifetime of the asset, assuming the underlying assets wouldn’t default. But, in terms of bankers’ incentives, no one could care less about how that asset played out as:

1) there was a model showing that the chance of things going tits up was near on impossible
2) bonuses would be in a few months time, and it would be decided by paper profits made that year

Anyhow, the reason I’m blogging this is that I just found out the Deutsche Bank credit traders just lost 100 million Euros, and that several desks have now been shut down. Further, I hear that Lehman Brothers have canned 8% of their global workforce in a month, that Goldman Sachs has a hiring freeze, and shrunk its graduate intake by 25%.

So it’s kind of a big problem. All those structured assets obfuscate

a) what the real level of risk is, and
b) who the hell owns that risk

(Of course I am heavily simplifying).

The Economist has been covering the credit/American sub-prime problem as a leader for the past month or so now. Not that I follow things in much detail, but I’m reminded that in the financial markets uncertainty is the norm, not the exception, and to my final point: you should read The Black Swan.

For further implications of the credit crunch, read how in the UK Northern Rock needed to be bailed out, almost GBP 2bn was withdrawn in the past 3 days, and that investment banks globally are set to lose $30bn.

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As an aside, the big problem with a lot of financial models is that they assume a normal distribution on variables where they shouldn’t. A normal distribution is fine for independent variables, but in most things where you are modelling human behaviour, things are far from independent (we are heavily influenced by what other people are doing; Facebook Apps are a good example of that). This in turn leads to problems where models heavily underestimate risks of rare events (the normal distribution inherently understates the probability of rare events).

burning, originally uploaded by Kulveer.

I went to Burning Man for the first time this past weekend. It was an interesting, and thought-provoking experience. I first heard of it when I read the Google Story a few years back, so I had some idea of what to expect, and was quite excited to go.

[For those of you that don’t know what it is, it’s quite hard to explain, but imagine thousands of people coming together in the middle of the desert to celebrate “self-expression, self-reliance, and art” in a temporary city (Black Rock City) that’s completely constructed by volunteers, where everyone leaves one week later, having left no trace.]

The quick way to describe it is that it was as close as you are likely to ever get to ‘hippy utopia’. I loved that a lot of modern societal norms seem to be cast off for a week and the people there were having a great time. One girl approached me out of the blue as I was sitting down listening to a band play, and offered me a hand massage. I said yes, and then asked her what she thought of Burning Man. She told me it was “like being at home”, that there was no place like it, and that she looked forward to it each year. I could tell she was genuinely happy. Anyway, she then offered to spray me with peppermint to cool me down, to which I answered yes, and I immediately felt sheepish as I had nothing to offer her (our alcohol was in the RV - an emphasis on giving/bartering is the norm; there is no money).

I definitely noticed a difference between those who had come well prepared (i.e. not us) and those that seemed like tourists or slightly ill at ease with the whole thing. The general vibe was one of giving; people everywhere were offering their drinks and food and generally being very welcoming.

Also, there were lots of naked people. Everywhere. I couldn’t help but wonder whether these people were ‘conventional’ in every day life and just let loose for a week each year at the playa, or whether these traditionally unconventional types (I’m loathe to say hippy again) that had congregated from all across northern America.

Anyway, the artwork I saw was pretty awe-inspiring. The highlight was this ‘temple’ that had been built and was burnt the day after The Man. A lot of effort had obviousy gone into building it. It was quite moving to see people writing messages, heartfelt apologies and confessions on the structure itself to loved ones who had passed away. I saw one man write a letter and break into tears uncontrollably and just sit there weeping, and another couple who had lost their baby and were putting up a montage as a tribute. It was very solemn.

The other image that came to mind was that this was what a human colony on Mars might look like some day. A lot of people had created unique buggies, adapted buses and decorated their bikes to get around (the playa is huge, afterall). It was invigorating to see so much individuality, and that people had made the effort to express themselves. It was a sight in itself to see how people were travelling across the playa. Contrast that to normal city life and transportation is positively bland (I’m looking at all the identical cars driving over the Bay Bridge right now).

Conclusion? I’d like to go again, this time with a little more preparation, now that I know what it’s all about.