Proving sociologists right: pencil pushers and Neardenthals stave off the next crisis by uniting on the trading floor
February 24, 2010
From the early debates between Adam Smith and Karl Marx, the benefits and dangers of a formal organizational structure have been of central interests to sociologists. A recent article on the Financial Times comments on an intriguing trend within London’s financial City that brings this problem to the fore. Banks appear to be merging the trading desks that specialize in trading different assets. Specifically, the FT comments on the practice of Derek Bandeen, a senior equities trader at Citi:
[Bandeen] has merged Citi’s cash equities and derivatives trading desks – a sea change for a business that had segregated the two for years. (…) “There is no way you can be a cash [equities] trader and not know what’s going on in the derivatives market. You’ll just be run over, again and again,” Mr Bandeen says. Bringing them together to create a trading environment that is more “multi-asset class”, in the industry jargon, is a trend that has been sweeping the trading rooms of London, driven by rapid advances in electronic trading.
The trend to merge desks is widespread among American banks, and beginning to take hold in European banks too. It is driven by the rise of trading strategies –arbitrage– that have led different securities to trade more in unison. “Today,” the journalist writes, “different types of asset can be traded against each other more effectively than through the more cumbersome telephone or floor broking methods of the old days. So one type of financial instrument, such as a share, is often affected by the behaviour of another, such as an option on that share.”
The problem, of course, is that such cooperation is limited by cultural differences across trading desks. According to Bandeen (cited in the article),
The typical stereotype is that equities traders think the derivatives guys are a bunch of pencil-pushing geeks who don’t understand stocks while the derivatives guys think the equities guys are a bunch of Neanderthals (…) The trick is bringing them together.
This sudden recognition of the importance of structure is a critical development for sociologists of finance. Since 2004, sociologists like myself and David Stark have been arguing that banks can exploit arbitrage opportunities by promoting communication across different trading strategies. As we explained in “Tools of the Trade,” in the specific trading room that we studied the manager had created a detailed set of management policies to integrate the different desks… against an incentive system that pushed people to the opposite. He was successful, and the numbers at the bank proved him right.
Post-crisis, the story has become a much higher stakes game. In his influential study of the credit crisis, Donald MacKenzie has argued that this cultural divide is precisely the reason for the credit crisis. Journalist Gillian Tett has made a similar argument. As MacKenzie wrote in his review of Gillian Tett’s Fool’s Gold,
The previously largely distinct worlds of CDOs and of mortgage-backed securities became increasingly linked from 2002 on. It was an encounter of two subtly different cultures, with for example quite different mathematical approaches. (…) The CDO world developed explicit and increasingly elaborate models of correlation (…) while the mortgage world handled the phenomenon entirely implicitly. In most investment banks, and also – as far as I have been able to discover – in the New York head offices of the rating agencies, separate departments handled mortgage-backed securities and CDOs based on corporate debt. In the investment banks, for instance, those different departments seem to have had surprisingly little to do with each other. The two cultures never really merged; instead, the CDO, a structure invented by the corporate-debt world, was applied to the products of the mortgage world. Members of both cultures now see the encounter as corrupting. ‘They’ – constructors of CDOs based on mortgage-backed securities – ‘took our tools’ and misused them.
The implications of the argument are key. Organization theory can be the next key tool in acquiring a trading edge and limit risk. If this is the case, we should expect banks to take a sudden and renewed interest in departmentalization, institutionalization, social networks, etc. And indeed, my current employer (the London School of Economics) may start offering a course in the sociology of finance to master students in management. A conference on the sociology of finance for hedge fund managers is coming up in June. One wonders what this might all lead to…