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A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation Paperback – December 10, 2008


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Product Details

  • Paperback: 304 pages
  • Publisher: Wiley; 1 edition (December 10, 2008)
  • Language: English
  • ISBN-10: 0470393750
  • ISBN-13: 978-0470393758
  • Product Dimensions: 9 x 6 x 0.8 inches
  • Shipping Weight: 12.8 ounces (View shipping rates and policies)
  • Average Customer Review: 4.2 out of 5 stars  See all reviews (76 customer reviews)
  • Amazon Best Sellers Rank: #299,326 in Books (See Top 100 in Books)

Editorial Reviews

Review

“Mr. Bookstaber wrote one of the best books about the causes of the financial crisis, A Demon of Our Own Design, and did so before the crisis erupted.”-- Floyd Norris, New York Times (June 25, 2009)

"A risk-management maven who's been on Wall Street for decades…Bookstaber's book shows us some complex strategies that very smart people followed to seemingly reduce risk—but that led to huge losses." (Newsweek)

"Mr. Bookstaber is one of Wall Street's 'rocket scientists'--mathematicians lured from academia to help create both complex financial instruments and new computer models for making investing decisions. In the book, he makes a simple point: The turmoil in the financial markets today comes less from changes in the economy--economic growth, for example, is half as volatile as it was 50 years ago--and more from some of the financial instruments (derivatives) that were designed to control risk." (The New York Times)

"Bright sparks like Mr Bookstaber ushered in a revolution that fuelled the boom in financial derivatives and Byzantine 'structured products.' The problem, he argues, is that this wizardry has made markets more crisis-prone, not less so. It has done this in two ways: by increasing complexity, and by forging tighter links between various markets and securities, making them dangerously interdependent." (The Economist)

"He understands the inner workings of financial markets...A liberal sparkling of juicy stories from the trading floor..." (The Economist)

"…smart book…Part memoir, part market forensics, the book gives an insider's view…" (Bloomberg News)

"Like many pessimistic observers, Richard Bookstaber thinks financial derivatives, Wall Street innovation and hedge funds will lead to a financial meltdown. What sets Mr. Bookstaber apart is that he has spent his career designing derivatives, working on Wall Street and running a hedge fund." (The Wall Street Journal)

"Every so often [a book] pops out of the pile with something original to say, or an original way of saying it. Richard Bookstaber, in A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, accomplishes both of these rare feats." (Fortune)

"a must-read amidst the current market chaos" (BusinessWeek.com)

"Bookstaber is a former academic who went on to head risk management for Morgan Stanley and now runs a large hedge fund. He knows the subject and has written a lucid and readable book. To his aid he calls mathematics (from Bertrand Russell to Godel's theorem); physics (particularly Heisenberg's uncertainty principle); and even -- meteorology." (Financial Times)

"The book covers a lot about risk management that is relevant to capital markets conditions today and the liquidity crisis." (Financial Times, Saturday 25th August)

"...an insider's guide to markets, hedge funds and the perils of financial innovation.  We saw plenty of those in 2007."  (The Sunday Telegraph, Sunday 25th November 2007)

"I cannot recommend this book too highly. It is a clear exposition of what the combination of derivatives, leverage and hedge funds can do to the markets.

In short, A Demon of our Own Design is a guide to the dangerous financial markets we have created for ourselves by the clever innovations of structured finance, derivatives, credit default swaps and other newfangled products that are a mystery to the ordinary investor and even plenty of the sophisticates in the investment business. To understand the demonic risks we're taking, read this book."--Forbes.com

From the Inside Flap

It's Wall Street's most painful paradox. Investors are more sophisticated than ever, are enabled by unprecedented technology, and protected by more government oversight and regulation than at any other time in history. Yet Wall Street is becoming a riskier and riskier place. Crashes and catastrophic losses seem commonplace. Hedge funds wreck on the financial shoals with a disturbingly familiar pattern. Worse, today's financial crises do not arise from economic instability or acts of nature, but from the very design of the financial markets themselves.

In A Demon of Our Own Design, Richard Bookstaber paints a vivid picture of a financial world that is ever edging toward disaster. As a hedge fund 'rocket scientist,' Bookstaber provides an insider's perspective to the tumultuous management decisions made by some of the world's most powerful financial figures from Warren Buffett to Sandy Weill to John Meriwether,as well as recounting his own contribution to market calamities. He designed some of the complex options and derivatives that, combined with the globalization of the world's markets and the ever-increasing speed of transactions, allow markets to slide out of control. And he explains why the best efforts of institutions on the front lines to create safeguards, manage risk, and regulate the markets may end up contributing to instability. Bookstaber argues that many of the financial innovations and regulations that are supposed to level the playing field instead make the markets more dangerous for all the players, big and small.

Drawing on his intimate knowledge of such infamous disasters as the 1987 Crash and the demise of Long-Term Capital Management, Bookstaber identifies the key areas that make markets vulnerable: liquidity that begets greater leverage; innovation that creates greater complexity; and a structure that demands a nonhuman level of rationality. The twofold solution he suggests—reducing complexity and breaking the tight coupling of transactions—goes against the prevailing winds of Wall Street, but will lead to a more robust and survivable market. --This text refers to the Hardcover edition.


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Customer Reviews

Financial derivatives make for perfect complex systems with tight coupling.
Gaetan Lion
I highly recommend this book to anyone who wishes to gain a deeper understanding of the processes that lay underneath the hood of modern market dynamics.
Mark
I found this book very interesting and full of information I haven't seen elsewhere.
John

Most Helpful Customer Reviews

165 of 175 people found the following review helpful By Mercenary Trader on September 13, 2007
Format: Hardcover Verified Purchase
In recounting his time as risk manager at a number of prominent houses (Morgan Stanley, Salomon Brothers, Citigroup etc.), Bookstaber completes the i-banking trifecta. First there was the Michael Lewis classic, Liar's Poker, detailing the juvenile bravado and macho antics of the trading floor. Then Jonathan Knee gave an intimate portrait of the i-banker deal making culture with The Accidental Investment Banker.

And now, in A Demon of Our Own Design, we get a glimpse at the risk management side of things... a sort of master plumber's walking tour through the bowels of the system, with technical descriptions of exactly what happens when pipes burst and boilers explode. (Some will find Bookstabers' level of detail intolerably dull; others will find it quite fascinating. I was in the fascinated camp.)

Nature of the beast

In describing the finer points of risk arbitrage, Bookstaber explains why it's normal -- expected even -- for trading desks to take a good whack every so often. The nature of the beast is to make relatively steady profits, month in and month out, and then give back a chunk of those profits when something goes haywire. (That's how you move huge sums on an arb desk; grind out small bets that are almost guaranteed to work, juice up the returns with leverage, and try not to be in the vicinity when the rare position goes kablooey.)

In light of this general modus operandi, perhaps it isn't surprising that the "quant" funds recently took a major hit (as of September 2007). They had been minting money for an extraordinarily long period, had the leverage to show for it, and now, after the recent "oops," seem to be generally back in business.
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127 of 142 people found the following review helpful By Aaron C. Brown TOP 1000 REVIEWERVINE VOICE on June 4, 2007
Format: Hardcover
This is an entertaining account of 25 years of financial disasters by a smart insider who is also a keen observer and witty storyteller. Some authors take simple ideas and cloud them with hairsplitting definitions and complex equations, real mathematicians like Bookstaber effortlessly work in deep concepts like sufficient statistics and state variables without any equations or formal mathematics.

The best part of this book is the context. If you read books on individual disasters the situations come across as complex and the people as tragic geniuses. If you read the one paragraph versions favored by the business press, the underlying trades seem impossibly simple, and the protagonists seem to be morons. This book shows the euphoria of winning trades when money flows in like magic, and the confusion and shock that result from unanticipated losses. There are many reactions to these losses: cut them quickly, ride out the storm, even double up the bets. Each of these sometimes works and sometimes makes the situation worse. Only after reading all the permutations and outcomes can you understand the stark choices posed as the disasters unfold. The players are neither idiots nor geniuses, they are smart but ordinary people, facing understandable human dilemmas.

This context is precisely what is missing in the chapter on engineering disasters. If you look only at disasters, when by definition all the safety precautions failed, it's no surprise that you'll conclude safety precautions are worthless. If you only look at the most dramatic disasters, it's no surprise you'll conclude that the most ambitious, advanced, complex and tightly-coupled systems are the most prone to catastrophe. Bookstaber relies on writers I call the dismal engineers.
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47 of 50 people found the following review helpful By D. C. Carrad on August 7, 2007
Format: Hardcover Verified Purchase
Extremely well-written and thought-provoking. The author has a wide range of interests and knowledge, from yield curve behavior to cockroach survival traits, and explains them all lucidly, simply and in an entertaining and practical manner. He has a deep understanding of the workings of the financial markets, and shares several unique perspectives in this book which I have not read elsewhere, and it is extremely valuable for that reason alone. He is one of those rare geniuses who can keep his autobiographical urge to an interesting, useful and entertaining minimum, only mentioning his personal experiences when they provide insights into larger themes (cf. Black Swans). The author does occasionally use the book as a platform for payback to former colleagues who have done him wrong, but this is done with a stiletto, not a blunderbuss, and is fun to watch. Always well-written, occasionally entertaining. Very highest recommendation.
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35 of 38 people found the following review helpful By Amazon Customer on December 17, 2007
Format: Hardcover Verified Purchase
Just a warning - if you don't know what LTCM stands for or have never heard of a "swap spread", you may want to read some other books first - Peter Bernstein's book on risk, or "When Genius Failed". The title is somewhat of a misnomer - this is more a collection of Wall Street war stories than an explanation of modern financial instruments and innovation. If you have the background to follow it, though, it is entertaining and scary.
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8 of 9 people found the following review helpful By Vasiliy Zhulin on July 18, 2009
Format: Paperback
In this book, Richard Bookstaber argues that complexity in the financial markets is an unfortunate evil, a consequence of ever more customized investment and hedging solutions. Unlike in other areas, innovation in finance does not make things safer, but instead more complex and hence more dangerous. Complexity by itself is not always bad, but combined with what Bookstaber calls "tight coupling," which means that all steps of a process are interlinked and dependent on each other with no slack, it makes for "normal accidents." Normal accidents are events that we believe to be incredibly rare - yet they occur much more frequently than expected.

How do we battle this problem? Bookstaber argues that more regulation and more transparency are both poor solutions. Regulation only increases complexity, further escalating the problem, and transparency leads to other various problems that stem from limitations of knowledge. Unfortunately, Bookstaber does not provide a clear solution. He believes we need to slow innovation in finance to reduce complexity and reduce leverage in order to give more slack to the system and hence help alleviate tight coupling. However, I don't see these as practical courses of action. Reducing complexity means being less responsive to clients' needs - something firms will never do in this industry. Reducing leverage means smaller returns, again something that the investment community overall is unlikely to agree on. Perhaps some regulation on leverage may be helpful, but hedge funds fall outside of common regulatory rules - and they have become a force to be reckoned with.

The book follows mostly a chronological format, from Bookstaber's early days at Morgan Stanley and Salomon Brothers to Ziff Brothers and Moore Capital.
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