A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation

I have had great difficulty reading this book firstly as I am not a quant nerd. Secondly, the author deems fit to draw comparisons with hedge funds and a host of unrelated topics eg. Chernobyl, Two Mile Island and the military and the Post Office (for heaven's sake)! The less said about the ill fated shuttles the better!! Third, the book is poorly written and/or badly edited as there are many duplications throughout the text an example of which is LTCM which crops up in every other chapter. Nevertheless, I also read the authors' presentation to the oversight committee of Congress where he did a complete about turn and in complete contrast to this book stated that better regulation was the way forward!
Confused? You better believe it!!

Loving this book. It really brings clarity to all the events that surround financial crises. Got the book on time and in perfect condition.

Something in the human spirit delights in and preserves Elephants, and is repulsed by cockroaches. And Bookstaber has picked the wrong hero. He's probably been listening to too much DEVO.

Bookstaber draws delightful lessons and reviews famous incidents well, and therefore this is a worthwhile general read on risk management and specific incidents, and highly recommended on that score. But this work is more directed to insiders (financial executives, bankers, risk managers, traders) as an editorial with examples than to observers as a phroduct of phun phinancial philosophy phor a broad audience of phunters.

But this work also draws an unintended and strong distinction between the worldviews and goals of traders and risk managers which is growing increasingly stark within financial houses. Traders think risk managers are killjoys, and risk managers think traders are madmen. Neither are correct, and both wrong for the wrong reasons, but Bookstaber unintentionally adds to the arguments of traders against the aims of risk managers with this work. Risk managers, like William F. Buckley, wish to stand athwart history and yell "stop." Traders want one more roll of the bones.

Bookstaber leads us to an examination of current conditions of complexity of markets and products and financial innovators versus conservatism and comfort with what is known and tractable. I'm a trader, and I'm not really in the business of increasing the comfort level of risk managers just because everything in the world isn't modelable, tractable, or measurable. Bookstaber wants this world, and wants us to stop trading while we wait for it to arrive.

Among Bookstaber's arguments is one that the world should pause in financial innovation, because the horizons and implications of new information are so removed from the locus of risk we cannot anticipate the consequences.

But this is a monumentally silly argument, for this is "the same as it ever was."

I got news for risk managers; you might as well waste your time trying to weigh the human soul, `cause you ain't never ever ever going to be able to put the innovation and complexity Genie back in the bottle. Human beings are creative and every time we think we've made something tractable, a new combination makes the ultimate tractability recede from the horizon of our comprehension. It is almost as if the world was *made* intractable to humans (and risk managers) at the margins of contemplation.

"The Theophany of Job 38: Gird up now thy loins like a man; for I will demand of thee, and answer thou me. Where wast thou when I laid the foundations of the earth? declare, if thou hast understanding. Who hath laid the measures thereof, if thou knowest? or who hath stretched the line upon it? Whereupon are the foundations thereof fastened? or who laid the corner stone thereof; When the morning stars sang together, and all the sons of God shouted for joy?"

Current rarefied work on portfolio optimization under partial consumption and partial accumulation of endowment under risk (JeanBlanc, Pham, Yor, etc) is one of the few instances where Theory of Financial Mathematics and meat-space do share a coincident surface. Most of theoreticians working here assume information arrives randomly, and has random coefficients of significance in changing security values. Now throw into that mix individual agents who sometimes use information more correctly and sometimes incorrectly and you have a market.

Bookstaber has no problem with passive reception of information, but he is overly cautious on the other element of information as used by humans: we create both good and bad information. New information is both received ("there's a storm a brewin'") and created ("look, I've invented a scale to measure storms!") and sometimes created with skewed intent ("you should buy my insurance, look at all these storms on my graph!"). Bookstaber doesn't like humans making other humans have forced economic choices, but this is inevitable because we are bounded by time.

Bookstaber's ultimate critique is he wants us to have more time (me too!), but it ain't happening, because time is the ultimate wasting asset....you can never get it back. Human beings are bounded in their capacity for hermeneutics and as discrete agents and operators are creators and consumers of information. As near as I can figure, information will always remain unbounded, and agents will always be saving and consuming discretely. Other agents will sort and prioritize information to bind those discrete choices of agents. Bookstaber wants to unbound our discrete time, and discritze our information choices: utopian and impossible.

Bookstaaber recognizes that financial innovation has increased complexity, but also dispersed risk, but objects to the result that *yes* some holders of that risk *don't* understand and are taking *more* risk than they do understand and the outcomes will be discretized horribly at their node, ..but that is the human condition and one of the curses of our dimensionality that makes the game work.

In other words: no need for a pause, and full steam ahead. I'm sorry if Bookstaber would like to take a breather so he can catch up with his measuring sticks and ferreting out the bad apples, but you might as well tell history to stop and the human condition to approach the wealth accumulation processes of ants.

Sorry, I'd prefer to keep making bets on even loaded dice rather than submit to the logical conclusion of Bookstaber's fears:

Just because it can't be measured doesn't mean it shouldn't be done. And every disaster and triumph in the single-man theory of history has us, and markets, as ever thus.

- Jaques "used bond buyer" Bachelier

At the time this book was published, the Wall Street Journal noted that things had changed since the time of the "problems" Bookstaber wrote about and that they were extremely unlikely to occur again. Rick Bookstaber has proved to be remarkably prescient. "A Demon of Our Own Design" provides the best perspective to date (06/08) on the credit crisis. The book's gossipy style doesn't detract from it. What does is Bookstabler's lack of imagination in prescribing the cure of blocking innovation. Yet, here too, he may be prescient as the regulators seem to be moving very much in that direction. Much better on this point is Steinherr's "Derivatives: The Wild Beast of Finance". In the end, though, one need look no further than simple hubris (as to which see Lowenstien's "When Genius Failed", the story of Long-Term Capital Management), and no regulatory structure can prevent hubris --- at least none that we'd want to live under.

This is one of the few books that explains the reasons for much of today's financial crises (as it relates to the banks, anyways), in a way that transcends sanctimony and overgeneralizations. Bookstaber has seen how the incentives to take risks permeate in an organization, and why that's generally acceptable. He is one of the few that highlights the importance of the tight interconnectedness of financial counterparties that spreads financial infection.