Roger’s Version: How to Rob a Bank

In the movie GoodFellas, there’s a wonderful sequence explaining how the Mob will “bust out” a restaurant: They use the restaurant’s good credit to load it with debt, use the debt to buy merchandise (liqour, cigarettes, etc.), and then simply walk out the door with the merchandise. Lather, rinse, repeat, until the restaurant is broke.

Roger Ehrenberg

Roger Ehrenberg, who runs an angel investor firm after making his money on Wall Street, and blogs sporadically but very insightfully, has a very clever explanation/recipe for ways someone can “bust out” a bank or investment firm: A step-by-step career path which The Hourly G can confirm from experience is exactly how the best & the brightest from Ivy League schools went about plundering Wall Street exactly like over-educated mobsters—Joe Pesci with better table manners.

According to Roger’s version:

[I]t didn’t take long before the best and easiest method of robbery popped into my mind (assuming staying out of jail is a priority): derivatives trading. Now I’m not saying that this is de-facto how derivatives traders operate; I’m simply saying that what is described below is a tried-and-true approach for extracting value for oneself without truly creating value for the firm and its shareholders. It has happened countless times throughout Wall Street and hedge fund history, and I’m sure it will happen again (it’s probably happening now).

Here is a straight-forward seven-step process for getting in the position to use derivatives trading to “rob the bank:”

1. Go to a fancy college, do well in math, CS and stats, and study those brain teasers that trading desks love to give applicants. If you didn’t go to a fancy college, work yours and your parents connections to try and secure a position. Absent connections, leverage your alumni network. Do whatever you need to do to get an interview.

2. Trade a little on your own, so you can say “I trade my own book” when asked, and have a trade idea in mind when you go for the interview. You will be asked this question.

3. Once you get the interview impress, show passion, intensity and how you are laser focused on making tons of money for your firm (and yourself). Take chances, be brash, stand out from the crowd.

4. Congratulations, you did it! Join the trading desk as a go-fer, indentured servant, whatever. Ask lots of questions without being annoying, and make sure you are studying the mechanics of how trades get done and how they get reflected in the firm’s risk systems.

5. Gain the confidence of others, build reputation, and position yourself for securing your own book. This can take a little time but be patient: It’s worth it.

6. When you get your book, really understand how P&L recognition works. If P&L is calculated on concepts like “inception gain” or “theoretical profit,” you’re in good shape. Also figure out the implied cost of capital. If your firm is charging you LIBOR flat, yippie! Another good fact. If it’s LIBOR plus a credit spread for the duration of the trade, less good but you can live with it if your P&L has the right revenue recognition characteristics.

7. What you’d now really like to do is enter into a large notional amount of longer-dated, short volatility trades. Book profit as theta decays, assuming you don’t blow up. if you do, well, your downside is zero and you can get a job at another firm for even having been in the position to take such massive risk. If you don’t, well hey now, all that time decay flows right to your bottom line. And with a large enough notional amount, your 8-12% of P&L can add up to some serious coin.

Did you create value? No. Did you trade well? If being lucky counts, then yes. And if you get paid and shortly thereafter the chickens come home to roost and your book blows up? Well, you’ve just robbed the bank!

Just like gangsters in the Bad Old Seventies, only with much nicer suits and no pasta bellies, the guys who followed this career path are the guys who brought the Shadow Banking sector to its knees in 2008.

And because there hasn’t been real reform since the crisis, they’re still around . . .