Risk Latte - Pied Piper of Morgan Stanley

Pied Piper of Morgan Stanley

Rahul Bhattacharya
June 20, 2008

Morgan Stanley is the second largest investment bank in the world and is a name to reckon with in the world of investment banking. It has an army of quants, traders, risk managers and other experts who know all about valuation of complex derivatives securities and contracts. It follows market best practices when it comes to risk management. Or so it would seem.

Last year in March, Nassim Taleb, who needs no introduction and who is perhaps more famous and better respected than anyone inside Morgan Stanley, told a rather large group of risk managers in Morgan Stanley that they really didn't know how to price risk; his main argument was that their models, the main engine for pricing and managing risk of derivatives securities and transactions, were faulty. In short, the models don't work.

There was disbelief, consternation and denial at this prognosis; but even the gurus of risk management must have found it difficult to laugh Taleb out of the room. So there was lot of debate.

Six months later the unthinkable happened. Morgan Stanley took a charge (write down) of $9.4 billion of its sub-prime mortgage related assets. The firm's traders had apparently misjudged "how fast and how far the prices of the debt would fall".

Moreover, in August 2007, on a single day, Morgan Stanley traders had lost $390 million in quantitative trading. They blamed the computer models which apparently could not account for widespread investor "panic" selling triggered by other events on the Street. And during the third quarter of 2007, the firm lost a total of $480 million mostly from losses arising out of quantitative trading strategies.

So computer models failed; math models failed and money was lost. Traders and risk managers were not at fault. Who can blame the Morgan Stanley traders and risk managers for such failure?

And now we get another credit derivatives trader at Morgan Stanley who either deliberately mis-priced his credit derivatives trades (to hide his losses and mislead his superiors) or worse, he simply didn't know how to value the trades. And the firm loses a cool $120 million.

Though not much has been revealed about the trader, it seems his name is Matthew Piper. He earned around $300,000 a year in salary, lived in a $2 million home and worked in a team at Morgan Stanley known "Investment geeks" because for them making complex financial bets on the market is walk in the park.

When we were kids we heard bed time stories about Pied Piper of Hamlin. Now the kids have a choice: they can ask their parents to tell them the story of Pied Piper of Morgan Stanley!


Any comments and queries can be sent through our web-based form.

More on Finance,etc. >>

back to top

More from Articles