So what went wrong? Was the Boy Genius of Deutsche Bank brash and reckless, or did his risk management handlers undercut him?
One could argue that if Mr. Weinstein could have held his positions (reportedly basis trades, that is, bets on the discrepancy between CDX indexes and the cash bonds which they supposedly tracked), he could have made much money. Yet, the handlers of Deutsche Bank’s prop desk money, the risk management team, became uncomfortable and pulled the plug, causing Mr. Weinstein to lose large sums of money. So who is at fault? The risk managers doing their job and cutting what seemed like bad positions (and so saving their jobs)? Or Mr. Weinstein, for not getting approval from his handlers to make very volatile trades that could have eventually made much money? That is, is he at fault for not getting staying power through a sign-off or a contractual right by informing his bosses ex ante (“Chief, if a crisis happens, I will lose $X first, but make $2X later, so you need to stick with me)? Or does fault lay with the Deutsche Bank bosses that gave Mr. Weinstein so much money to bet with in the first place, taking the easy hundred million dollar profits in past years and then taking the multi-billion dollar loss in 2008 (what Taleb likened to picking hundred dollar bills up in front of an oncoming bulldozer)?
The more scary thought is that the entire CDS market could have collapsed with all its major broker-dealers and counterparties defaulting. So, even if you bet right and won, you would have really lost because the other side would be bust and couldn’t pay you. Many smart hedge fund managers avoided CDS just for this reason (but alas, lost cash or good securities by keeping them in a Lehman Brothers prime broker account that could be re-hypothecated, and so are in receivership after Lehman went bust). Mr. Weinstein, and his former employer Deutsche Bank, were playing with zappo lighters while standing on a wire above jet fuel – the first hard winds coming by blew them over.
Originally published at Risk Over Reward blog and reproduced here with the author’s permission.