Kill reckless traders!

Gene ExpressionBy Razib KhanFeb 9, 2009 11:16 PM


Sign up for our email newsletter for the latest science news

Below I semi-seriously mooted the possibility of killing individuals who destroy enormous amounts of wealth through risk-taking which inevitably results in particular instances losses. The main issue is that the upside to risk is unbounded, but the downside is constrained (i.e., bankruptcy, etc.). Given a particular personality type it seems absolutely rational to keep cranking up the bets which have an enormous upside which might translate into incredible personal wealth. Huge losses are generally absorbed by institutions or investors (granted, one might lose one's job, but there are always other jobs). That seems a major moral hazard, and I don't think we have a good handle on it yet. Nassim Taleb, author of The Black Swan, seems to be pointing to the same thing in this interview with CNBC (jump to ~7 minutes). The talking heads point out that compensation isn't a major proportion of the money on the table, but the compensation is tied to huge amounts of capital. A trader who destroys their own career can take down a whole firm, and in a global financial system with interlocking obligations they might then bring down the whole system. If the depiction in When Genius Failed: The Rise and Fall of Long-Term Capital Management is accurate, the hubris of specific partners, Victor Haghani and Larry Hilibrand, brought the world's financial system to the precipice in 1998. In fact, Larry Hilibrand came close to scuttling the bailout which saved LTCM and averted the chaos because he was weighing whether it might be in his optimal

personal interest to file for bankruptcy because of debts incurred when his wealth was around $500 million

. LTCM was a partnership so Hilibrand's signature was a necessary condition to a resolution. These sorts of issues aren't limited to the financial markets. A commenter mentioned that programmers who create viruses maliciously can cause a great deal of damage. In fact, someone with a great deal of talent and malice could profit handsomely by causing chaos which might produce predictable responses in the financial markets. Today we think that serial killers and their ilk are the apogee of human evil. I think this is not a totally rational stance in the context of the modern world, though it is grounded in real moral intuition. The fact that our hardwired reflexes are not sufficient to prevent many automobile accidents is something which evolutionary psychologists point to as a negative consequence of the rapid changes in our environment which are now out of sync with our adaptations. Though car accidents kill many in the aggregate, any given car accident only kills a few individuals. In a world of automated financial instruments single "accidents" have the potential to harm many more individuals, increasing morbidity if not mortality. Update: I feel like I should give examples for why I believe that the downside is constrained. Larry Hilibrand who I referred to above lost $500 million in paper wealth. Obviously a disaster for him. But, he avoided filing for bankruptcy and kept his home. The partners were granted a $500,000 salary for the year and a half that they managed LTCM as it unwound its investments. They were bitter about this piddling sum, though it was surely appropriate punishment for the recklessness which they engaged in. Set next to the hundreds of millions than the major partners were worth in early 1998 a salary of 500 K was basically zero. But was this truly a penalty for their behavior? If they were fined hundreds of millions of dollars to reflect the change in sign of their impact on the market there would be no way to collect, as they didn't have the money. Nick Leeson, whose trades for Barings Bank resulted in the collapse of the 200 year old institution is doing well now:

Nick Leeson fled Singapore, but was arrested in Germany and extradited back to Singapore, where he was convicted of fraud and sentenced to six and a half years imprisonment. While in Changi prison he was diagnosed with cancer, recovered, and was divorced by his wife. He wrote an autobiography, Rogue Trader, covering the events leading up to the collapse. Film-maker James Dearden later dramatized the book in the film Rogue Trader. In 2006, Leeson was appointed chief executive officer of Galway United, an association football club in Galway, Ireland.

Granted, Leeson did spend time in jail. But if this is the worst outcome for someone who brought down a major financial institution I really don't see that it's irrational for people be try out their luck, and hope that the coin lands on the right way. Most of the partners at LTCM are still in the financial business, many at the successor fund to LTCM. Unlike Icarus these people did not die after getting too close to the sun. Rather, they settled down at a lower level. If the consequences for risk taking on the downside are modest comfort as opposed to glorious wealth, where is the rational (as opposed to ethical or moral) argument for why someone who is willing to trade variance for increased expectation not swinging for the fences?

1 free article left
Want More? Get unlimited access for as low as $1.99/month
Already a subscriber? Log In or Register
1 free articleSubscribe
Want unlimited access?

Subscribe today and save 70%


Already a subscriber? Log In or Register
More From Discover
Recommendations From Our Store
Shop Now
Stay Curious
Our List

Sign up for our weekly science updates.

To The Magazine

Save up to 70% off the cover price when you subscribe to Discover magazine.

Copyright © 2021 Kalmbach Media Co.