Vincent Lepinay and the fragile codes of financial innovation

July 25, 2011

I just came across an extremely timely book. Vincent Lepinay, a sociologist at MIT, has just published Codes of Finance: Engineering Derivatives in a Global Bank.

Vincent did his PhD with Michel Callon and Bruno Latour at the Ecole des Mines. The book is based on his dissertation at a large French bank active in derivatives (ahem! one wonders which one that would be… ). Even though the research was done before the credit crisis, the book’s timing is right. At a time like now, when the legitimacy of financial innovation is being questioned everywhere (stay tuned for Fabian Muniesa’s research project on responsible innovation), Lepinay’s book opens the black box of how innovation takes place in high finance. As the publisher notes:

Codes of Finance takes readers behind the scenes of the equity derivatives business at one of the world’s leading investment banks before the crisis, providing a detailed firsthand account of the creation, marketing, selling, accounting, and management of these financial instruments–and of how they ultimately created havoc inside and outside the bank.

Princeton Uni Press (which is doing a terrific job at advancing work in SSF) is offering a PDF of the first chapter here. Judging by the title and the free PDF, the book appears to center on the problem of knowledge management in an investment bank. Lepinay writes (p. 16):

Codes are refrains. They turn chaos—“organized” chaos, in a bank in search of ever more profit and turned into a market with fierce competition among different traders into order through simplification. Gilles Deleuze offers penetrating, if difficult, insights in a theory of the code as refrain in A Thousand Plateaus (1987 [1980]). He defines refrains as always simultaneously cognitive and topographical: they bring order into the world by acting as frames that pacify the chaos of the surrounding activities that threaten to shatter each and every form of stability. Simultaneously, refrains also define topographies. Often, they are used with a special intent to set the boundaries of understanding: enabling some, disabling others. They can only be uttered in special situations, within a circle of authorized operators and distant enough from others not privy to their formulas and their powers to decode. Traders and engineers do not share the computer codes of their pricers with the salespeople: they strive fiercely to retain their monopoly as price makers over that crucial instrument in the room so that they can exclude every other employee from that zone. Salespeople do not share with the back-office manager the detailed history of the deals they have negotiated with their biggest clients or the written notes they have on these clients. During the tense period of product issuance, they engage in complex dances with clients across the perimeter of the bank. When mastered, the codes put the operator in control of his or her perimeter and help define his or her milieu. These codes offer an entry into the competitive topography of the bank: all operators want to make money by selling as many contracts as possible, but they also have to borrow circuitous routes to achieve that goal. Some need to use computer programs churning out prices, while others need to accumulate information about clients to better anticipate their preferences.

Knowledge management. Indeed, a critical problem of investment banks — and one that Donald MacKenzie has emphasized as the key cause for the credit crisis. In my work with David Stark, we have looked at the mechanisms that the bank put in place to overcome these problems.

One hopes that Lepinay’s work will bring about the conversation that financial economists are not having. Addressing questions such as:
– How do banks develop an coherent understanding their own products — across their various teams and divisions?
– How are these products competitively modified?
– What can go wrong with financial innovation?
– What should be done about it?

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