Narrative Fallacy

CARLOS THE EMERGING-MARKETS WIZARD

I used to meet Carlos at a variety of New York parties, where he would show up impeccably dressed, though a bit shy with the ladies. I used to regularly pounce on him and try to pick his brains about what he did for a living, namely buying or selling emerging-market bonds. A nice gentleman, he complied with my requests, but tensed up; for him speaking English, in spite of his fluency, seemed to require some expenditure of physical effort that made him contract his head and neck muscles (some people are not made to speak foreign languages). What are emerging-market bonds? “Emerging market” is the politically correct euphemism to define a country that is not very developed (as a skeptic, I do not impart to their “emergence” such linguistic certainty). The bonds are financial instruments issued by these foreign governments, mostly Russia, Mexico, Brazil, Argentina, and Turkey. These bonds traded for pennies when these governments were not doing well. Suddenly investors rushed into these markets in the early 1990s and pushed the envelope further and further by acquiring increasingly more exotic securities. All these countries were building hotels where United States cable news channels were available, with health clubs equipped with treadmills and large-screen television sets that made them join the global village. They all had access to the same gurus and financial entertainers. Bankers would come to invest in their bonds and the countries would use the proceeds to build nicer hotels so more investors would visit. At some point these bonds became the vogue and went from pennies to dollars; those who knew the slightest thing about them accumulated vast fortunes.

Carlos supposedly comes from a patrician Latin-American family that was heavily impoverished by the economic troubles of the 1980s, but, again, I have rarely run into anyone from a ravaged country whose family did not at some juncture own an entire province or, say, supply the Russian czar with sets of dominoes. After brilliant undergraduate studies, he went to Harvard to pursue a Ph.D. in economics, as it was the sort of thing Latin-American patricians had gotten into the habit of doing at the time (with a view to saving their economies from the evils of non-Ph.D. hands). He was a good student but could not find a decent thesis topic for his dissertation. Nor did he gain the respect of his thesis advisor, who found him unimaginative. Carlos settled for a master’s degree and a Wall Street career.

The nascent emerging-market desk of a New York bank hired Carlos in 1992. He had the right ingredients for success; he knew where on the map to find the countries that issued “Brady bonds,” dollar-denominated debt instruments issued by Less Developed Countries. He knew what Gross Domestic Product meant. He looked serious, brainy, and well-spoken, in spite of his heavy Spanish accent. He was the kind of person banks felt comfortable putting in front of their customers. What a contrast with the other traders who lacked polish!

Carlos got there right in time to see things happening in that market. When he joined the bank, the market for emerging-market debt instruments was small and traders were located in undesirable parts of trading floors. But the activity rapidly became a large, and growing, part of the bank’s revenues.

He was generic among this community of emerging market traders; they are a collection of cosmopolitan patricians from across the emerging-market world that remind me of the international coffee hour at the Wharton School. I find it odd that rarely does a person specialize in the market of his or her birthplace. Mexicans based in London trade Russian securities, Iranians and Greeks specialize in Brazilian bonds, and Argentines trade Turkish securities. Unlike my experience with real traders, they are generally urbane, dress well, collect art, but are nonintellectual. They seem too conformist to be true traders. They are mostly between thirty and forty, owing to the youth of their market. You can expect many of them to hold season tickets to the Metropolitan Opera. True traders, I believe, dress sloppily, are often ugly, and exhibit the intellectual curiosity of someone who would be more interested in the information-revealing contents of the garbage can than the Cézanne painting on the wall.

Carlos thrived as a trader-economist. He had a large network of friends in the various Latin-American countries and knew exactly what took place there. He bought bonds that he found attractive, either because they paid him a good rate of interest, or because he believed that they would become more in demand in the future, therefore appreciating in price. It would be perhaps erroneous to call him a trader. A trader buys and sells (he may sell what he does not own and buy it back later, hopefully making a profit in a decline; this is called “shorting”). Carlos just bought—and he bought in size. He believed that he was paid a good risk premium to hold these bonds because there was economic value in lending to these countries. Shorting, in his opinion, made no economic sense.

Within the bank Carlos was the emerging-markets reference. He could produce the latest economic figures at the drop of a hat. He had frequent lunches with the chairman. In his opinion, trading was economics, little else. It had worked so well for him. He got promotion after promotion, until he became the head trader of the emerging-market desk at the institution. Starting in 1995, Carlos did exponentially well in his new function, getting an expansion of his capital on a steady basis (i.e., the bank allocated a larger portion of its funds to his operation)—so fast that he was incapable of using up the new risk limits.