Shadow Banking

by C. M. Albright

  At 9.35am on Tuesday May 9th 1995, Miles’s line rang. It was Nick.

  'Miles, can you pop down to JJ’s office now please.'

  'Sure.'

  Miles punched the release key on the phone board and gently placed the handset back on the desk. In JJ’s office, the weekly risk meeting was underway. The heads of the trading desks met once a week with senior management to discuss markets and the risk positions of the bank. It was rare for others to be invited to join this senior cabal even as a one off.

  As Miles pushed back his chair, stood up and made his way across the trading floor, he knew he was being watched. It was unprecedented for a graduate so new to the floor with only a few months’ experience to be invited to offer an opinion. Miles closed the door to JJ’s office after him and turned to see a collection of faces staring straight at him: the Head of FX Trading, Brian Holloway; Head of Treasury, JJ Pietersen; Head of Rates, Eddie Walters, known as Big Ted; Keith from the spot desk, along with Nick and David. Not since the presentations they had been asked to deliver during the graduate training course had Miles seen such a concentration of the bank’s senior management in one room. But Miles wasn’t intimidated. This was where he belonged. He might have been considerably younger than these people but if worth was to be measured by potential rather than experience then he was easily their equal. And it was this confidence that made him feel calm.

  'Here, Miles …' JJ gestured to the chair at the head of the table. 'We’ve been debating the current dollar weakness. Both Nick and David have mentioned you have some strong views on this topic. So we thought it best if you gave us your thoughts in person.'

  Miles looked at Nick and David with a new-found respect. They had not attempted to pass his views off as their own but had recognised that he should be held accountable for his own opinions whether right or wrong. For Miles, that’s all he had ever wanted.

  Miles sat down and leaned back in his chair. 'It’s clear that we don’t need to debate the fundamental reasons why the dollar is weak but there are a number of risk events that could cause a stop-loss rally in the dollar against a market that is complacently short.' As Miles continued he felt he was on solid ground. All those years with his grandfather; all those years at Harvard studying economics. This stuff fascinated him. But what also enthralled him was the power it could bring him. And money. Sitting around the table were clever and successful people. All men. But he doubted if there was one of them who had grown up with as much of a burning passion for trading as he had. It was unlikely. Statistically. He might not know as much as these people today – their experience counted for so much – but he had grown up dreaming of moments such as this. Moments when he could allow all that thinking, all the quiet contemplation, all the research, all the newspapers, magazines and books, to pour forth edited by a mind that was, in so many ways, a product of his dear grandfather. Miles had sat in his grandfather’s office for so long and listened to him and watched him with such devotion that not only did Miles echo the old man’s fiercely analytical mind but also his mannerisms and tics. As he spoke – and spoke well he knew – he found his hands moving towards the desk. Something less than gesticulation, he moved them on the table, just as his grandpa had done before him, opening his hands out or occasionally clenching a fist, as though moulding his narrative with his fingers.

  Miles spoke concisely and impassively. The Trenchart Colville top brass were impressed. That much was clear. But this wasn’t showboating, this wasn’t hypothetical. This was reality. For Miles, this moment was not just about P and L, it was all about credibility. Being credible was everything.

  'What’s the net dollar position across all books?' asked JJ.

  'Overall,' said Brian, 'we’re running 150 million short across a basket of currencies.'

  'OK so one and a half million dollars P and L per percent move,' said JJ.

  Miles knew this was the time to keep quiet. The debate was shifting to the risk and any attempt by him to comment would be seen as arrogant. He sat very still in his seat and listened intently.

  'How far could this squeeze go and where are the stops on the upside?' asked JJ looking at David.

  'We’ve been discussing this,' said David nodding his head towards Miles. 'We think the key is a break above 1.3880 in dollar mark. It’s the fifty day moving average and it could get really messy above there. If it goes, we could easily see a test of 1.45 pretty quickly.'

  'So what’s the best way to play it?' asked JJ looking at Miles with a half-smile. 'It’s your view so you must have given it some serious thought.'

  Nick Stevens smiled and leant forward on his elbows to get a good look at Miles at the head of the table. Most other employees out there on the trading floor, even ones who had been with the bank for many more years than Miles, would have been sweating at this point. What would golden balls make of this one?

  'I think there is real value in owning some three month 1.40 dollar calls which are currently thirty delta. Vol is back to the lows of last month and the daily decay of owning these is only 1.25 pips for the next two weeks. If spot breaks higher, vol will pop at least one to two vols higher and these options have 2400 dollars of vega per million. A spot move to 1.4250 in the next two weeks I can conservatively estimate will produce a P and L of 25000 dollars per million. Assuming we do them live of course.'

  JJ smiled and nodded. It was an excellent idea. He turned to look at Brian and Keith. 'Alongside that,' he said. 'Do you think we should buy some dollars for the management book?'

  'I like that idea,' said Keith. 'I’d be tempted to be long a hundred here and if we break above that eighty level, buy another hundred. I think we should be long two hundred of Miles’s option idea; the net delta on that is long sixty and we have half a buck of vega in the tin.' He glanced at Nick and said, 'What do you reckon the delta of those calls will be when we bust through the resistance?'

  'Fortyish?' said Nick looking at Miles.

  'About that I reckon,' said Miles.

  'Cool,' said Keith. 'So up through 1.40 we’ll be long north of three hundred. But where’s the chop on all this?'

  'We’re wrong below 1.3450, it’s the low of the year,' said David. 'That’s where the stop needs to go.'

  A period of extended silence fell upon on the room.

  'Thank you, Miles,' said JJ. 'We’re going to talk some more now but your insight has been most valuable.' It was time to go.

  Miles went to the kitchen area and as he made a cup of coffee, he replayed the meeting in his head and guaged its meaning. He had spoken well and clearly what he had said had not only impressed but had added much value to the debate. But key for Miles was that he had been given the opportunity and when given it had been taken seriously. He felt a sense of acceptance and enjoyed the realisation that he wasn’t worried if he was wrong. Trading was all about risk reward and risk reward in this case was very compelling. Of course they could get stopped out. That was the game.

  Back at his desk, Miles noticed that the risk meeting was breaking up and the senior managers were returning to their desks. As Miles sat down, Nick clapped him on the back.

  'That was pretty impressive stuff in there Miles. We’re going to do it. We need to get to work.'

  'Where did they put the stop for the prop book?'

  'At 1.3450. Let’s get some on for our book too, after we’ve got JJ’s done first. Keith’s already on the case on the spot. We’ll run ours delta hedged and just get the upside gamma on. We can let our deltas run of course.'

  The rest of the day was crazy, calling other banks to buy options while the broker boxes were alive with noise as they worked their interest. Miles noticed that JJ was spending a lot more time on the trading floor, much of it standing within a few feet of Miles and Nick. Word spread at speed that the senior management were buying dollars for the prop book. Those traders that were short were presented with a dilemma. If they stayed short, the market exploded and they got stopped out, they would look like they didn’t trust
the management’s judgement. If they went long too and the dollar collapsed, not only would they be ironed out but it would look as though they didn’t have the courage of their convictions being short in the first place. Within minutes, the general consensus was that the only safe trade was to go flat and jump on the move either way. The Miles Ratner-induced dollar buying frenzy at Trenchart Colville continued throughout the afternoon.

  By 4 o’clock, the position had been put on. Miles picked up the handset and dialled HR.

  'Bonnie Sawyer.'

  'It’s me. Third floor disableds, five minutes.'

  'Er, OK.'

  The line went dead.

  Not a word was said when they met. They had been meeting like this on a regular basis ever since their taxi ride at the Christmas party the previous year. Bonnie had wanted their relationship to develop beyond clandestine meetings and spontaneous couplings but if that was not to happen then she was happy enough to continue with the spontaneous couplings alone. In that regard, Miles had picked her out especially. The sex was rapid and intense, almost violent, as Miles hoisted her onto him and drove hard against the cold white-tiled wall. When it was over, they smiled at each other, readjusted their clothing and went their separate ways.

  At 5 o’clock, Miles had arranged to meet Al and Fergal in the Golden Hind.

  'Here comes the superstar trader,' Fergal shouted across the bar. Miles grinned as he joined them and Fergal threw his arm around his shoulders. 'May I say, how honoured I am,' went on Fergal, 'to be able to breathe the same air as a bona fide Trenchart Colville legend-in-the-making.'

  'Don’t take the piss,' said Miles.

  'Here you go, here’s a pint of piss,' said Fergal, passing him a pint of London Pride.

  'I guess congratulations are in order,' said Al.

  'What the hell for?' asked Miles.

  'Oh come on, you know what for. You’re the talk of the trading room.'

  'I’m just doing my job, that’s all.'

  'Pretty bloody well by the looks of it.'

  'You cocky little fecker.' Fergal spoke the words into his beer glass as he finished his first pint of Guinness. 'Now the most important aim of this evening’s beer consumption is to ensure that Miles here drinks enough so as to prove to us that he hasn’t abandoned his true friends at this time of great achievement. Personally, I think a little hangover can do wonders for one’s trading abilities. What do you reckon, Al?'

  'Totally.'

  It was banter – as Fergal liked to call it – nothing more, but Miles knew that banter could lead to serious drinking, drinking that could make getting up in the morning at 5.15am, doing fifty press-ups and going to the office almost impossible. In all the months that he had been at the bank, he had played the game. Drinking was an important part of the social fabric of the bank. It was crucial to be seen to be part of it. Going home early wasn’t necessarily frowned upon, it was just that the people who did so on a regular basis – particularly in their first year – were looked upon as though they were almost part-time. If you were under twenty-five years old and male then drinking in the Golden Hind, either at lunchtime or straight after work, was part of the working day. Already, in the brief time they’d been at Trenchart Colville, Fergal had made a name for himself throughout the entire bank for his amusing after work antics. Miles had seen how men at the bank – those locked solidly into their domestic lives who could no longer afford the time to regularly drink late into the night – had started to revere Fergal and live their lives vicariously through him. But Miles also knew that Fergal was only allowed to get away with his antics and behaviour because he had the makings of a very good spot trader. If his credibility had started to suffer, the hours he spent in the Golden Hind and the ridiculous situations that he always seemed to manage to engineer would not have seemed so funny. He would have been just a bum. The situation that Miles had found himself in at the risk meeting earlier meant that he was in a peculiarly advantageous position. But while he felt confident that his analysis was strong, maintaining the level of acceptance he now had at Trenchart Colville was vital. There was no way that he could wind down, relax and enjoy a few after hours drinks. And as for going in to work with a hangover, right now, that was out of the question. This was far too important. He needed to be on his game. He finished his pint with the second of two large gulps.

  'Right, well this cocky little fecker’s taking himself home.'

  'You’re joking.' Fergal looked affronted. 'It’s only just gone six. What are you talking about?'

  'If things don’t work out tomorrow then I’m in the crapper.'

  'There’s nothing you can do about it now. Either they will or they won’t. There’s no point worrying about it. You might as well have a few beers and cast yourself at the mercy of your own destiny. Come on ...'

  This was Fergal at his most dangerous. He made staying in the pub sound like a noble and brave endeavour and painted leaving, going home, as a desertion, a sign of moral cowardice. But Miles was resolute. He might allow his will to crumble on any other night but tonight he needed to be alone, to think, judge, evaluate and prepare.

  'I’ll see you in the morning.' Normally he would get another round in for Al and Fergal before he left, but even this would allow Fergal more time for leverage, to intercede with one of the bar staff, all of whom Fergal now knew on a first name basis, and insist that the number of pints ordered was increased by one.

  Miles turned and made for the door.

  Al called after him: 'Miles, come on, one for the road.'

  One for the road had become like a mantra for the three of them during their drinking sessions and on any given evening, the ones they had for the road sometimes outnumbered the rest of the drinks they consumed. By last orders in the Golden Hind, Fergal would usually resemble some sort of manic theatre director co-ordinating his cast and crew comprised of anyone who happened to be within his close proximity. One of his favourite turns was the co-ordinated consumption of 'ridiculous drinks', something that had already taken on legendary status at the bank.

  'How about a ridiculous drink?' Fergal would enquire and proceed to invite suggestions from anyone who happened to be in the pub before ordering wildly inappropriate and sometimes downright bizarre concoctions. As Miles had found out only a couple of nights previously, perception can be radically altered after half a pint of Advocaat, Blue Curacao and Lea & Perrins sauce. There was no way that he could allow a similar fate to befall him tonight. He knew that his going home at such an early hour would be seen by Fergal as a betrayal and sure enough, as he made his way towards the door, there came the unmistakable sound of Fergal’s shoes slamming down on the pub’s floor boards. A vast hand was placed on his shoulder and he was spun around.

  'Not since Judas sold out that fella with a beard has there been such behaviour. Now stay and have one for the road with me.'

  'I’d love to Fergs but really, I got to go.' Miles reached up, put his arm around Fergal’s neck and pulled him into a bear hug. This was a good move as he had noticed that physical affection made Fergal strangely compliant. But it was only ever momentary and Miles could see that Fergal was about to come back with another barrage of reasons as to why he should stay and drink. Before he could articulate them, Miles was out of the door and off down the street.

  Miles needn’t have worried. Over the next twenty-four hours, the dollar seemed to have found a base and started to grind higher. At six o’clock London time the following day, US trade representatives announced that they would be using sanctions to force the Japanese to open their borders to more American made goods. This was a direct attempt to narrow the trade deficit, one of the major reasons for the short dollar trade. On the back of this came an announcement from the Germans that their economy would suffer if the Mark remained overvalued, and speculation started to grow that the Bundesbank might cut interest rates. These were amongst the risk events that Miles had mentioned in the risk meeting not forty-eight hours before. The ensuing short sque
eze was brutal. Investors started to buy dollars back but there was more demand than supply, driving the dollar through the roof. The breach of the 1.3880 did indeed prove the acceleration point and over the next two days, the dollar mark topped out above 1.45. The options in the prop book had tripled in value and spot position alone was up ten million. Miles estimated that Trenchart Colville had made around twenty million dollars in three days.

  Miles found himself in many conversations over the next few days. People he had never spoken to before engaged him at his desk, in the kitchen, in the lift and even in the men’s room. What was he thinking now? They all wanted to know.

  At the risk meeting the following week, Miles was invited to attend right from the start. After the initial severe rally in the dollar, the next few days had seen sideways but choppy price action. The tone of the meeting was universally dollar-bullish. Miles was struck by how these experienced and hard-headed guys were so quick to play the trend. JJ felt that they should leave a wide trailing stop loss on the trade but specifically asked Miles his opinion.

  'We’ve caught the squeeze really well but the price action is not as encouraging as I would have hoped to the upside. Any weak US data and we could slip lower again. I also think there is a growing chance of a Mexican default which is clearly not dollar-positive. Position-wise, it feels like the short-term market is long dollars now. Dollar mark below 1.43 is the trigger point for a move back lower, I think.

  The irony of a twenty-two year old kid advising caution to the forty-five year old head of treasury and capital markets was not lost on Nick Stevens.

  'What do you think?' JJ asked Nick.

  'Vol is three and a half vols higher from where we bought the options,' said Nick. 'I think taking profit there by selling the calls would make a lot of sense and running a trailing stop on the cash positions.'

  The option desk’s sudden caution caught the senior management by surprise. After all, it was their idea. JJ decided to take profit on half of the options position and bought the trailing stop up to 1.40, considerably lower than Miles had wanted.