17 May 2007
We're told that in 1992, twenty Ivy League football players visited Japan, to play an exhibition game against Japanese college kids. Of course, American football isn't big in Japan, and the Ivy team (which would have been mincemeat before, say, the Boilermakers or the Sooners on even a bad year for either of the latter) handily defeated the Japanese who lent themselves to the show.
On this trip, Princeton's contribution to that all-star-Ivy team, John Malcolm, encountered a Princeton alum, Dean Carney. (I'll use their names as given in the book here. For their likely real names, see Monday's post.) Carney was a big-wheel at Kidder Peabody's Tokyo office, and he suggested Malcolm contact him about a job if no pro football career panned out.
None did, so Malcolm did, in 1993. Malcolm became one of KP's two Osaka-based traders. This lasted until April 1994, when KP discovered a $350 million "accounting glitch," and assigned responsibility for the glitch to one of its managing directors, Joseph Jett. KP (and its corporate parent, General Electric) made sweeping cutbacks in their trading operations as a result. Both Carney and Malcolm -- neither of whom had anything to do with Jett's accounting trickery -- were out of jobs, and they went their separate ways.
Malcolm took a position with a venerable English bank, Barings. He was again to work out of Osaka, but this time his orders were coming from Singapore, where Barings' star trader, Nick Leeson, held court.
Leeson, though, was making huge unauthorized trades during this period, and he was losing ... big. In January 1995 he made an enormous bet on a rise in the key Japanese stock exchange index, known as the Nikkei ... large enough so that if he won, he would recover all his losses. But of course he didn't win. That huge bet went against him, due to the Kobe earthquake January 17, and its devastating effects on Japan's economy.
After a brief period as a fugitive, Leeson was captured and did prison time. That didn't save Barings, which went into receivership. For the second time in eight months, a superiors malfeasance had cost Malcolm a job.
He called Carney for help. Carney, meanwhile, had founded a hedge fund, and Malcolm was soon trading for it. Mostly index arbitrage. What does that mean? In brief, there were by the 1990s funds in existence tracking most of the world's major stock market indexes. The idea is that someone might want to bet on the direction of, say, the Dow Jones, without having to invest in each of its component stocks. The managers of the index fund, by pooling a lot of investors' money, can of course more easily invest (according to their weight) in each of the components, and all the investors have to watch is the average itself. An "arb play" in this context means that a trader buys the components while selling the index-tracker fund, or vice versa, in order to take advantage of inefficiencies in the tracking process.
Anyway, Carney hired Malcolm again to come to Tokyo and arb the Nikkei and its components.
In 1994, the Hong Kong government created a tracker fund for the Hang Seng -- its equivalent of the Dow Jones or the Nikkei. [BLOGGER CORRECTION. The Mezrich account makes these dates seem plausible by a gross foreshortening of the events. The tracker fund actually came about as a result of actions taken by the government during the currency crisis of 1998.] In 1995, after Malcolm was settled into his Tokyo job, a company named Pacific Century Cyberworks (PCC) merged with Hong Kong Telecom, and under the terms of the tracker funds' charter, its managers had to buy $225 million worth of PCC stock. [AGAIN. MY MISTAKE, though with authorial encouragement. Mezrich is referring here to events of the year 2000].
Everybody knew it was going to have to do this, so a lot of traders tried to get a risk-free profit by front-running this deal, i.e. buying PCC stock ahead of the fund's expected purchases.
Malcolm, though, discovered that the tracker fund wasn't going to buy the PCC stock through the exchanges at all. It made a private off-exchange deal with PCC's founder Richard Li. This meant that, when the day of the expected fund purchases arrived and no purchases took place, there'd be a strong downward pressure on the stock price.
Accordingly, on Malcolm's suggestion, Carney's hedge fund took a "short" position on $100 million of PCC stock. When the big day arrived, and the tracking fund didn't make the expected purchases, the price dropped dramatically, and Malcolm covered the short position, winning his firm more than twenty million dollars.
This one deal made Malcolm a star, known to expat western traders throughout east Asia as their "hot young gunslinger."
The ending of the book turns on another, quite similar, but even larger deal involving the addition of several high-tech firms to the Nikkei index. This is the deal that justifies the book -- Malcolm made Carney's firm five hundred million dollars in cash out of the restructuring of the Nikkei.
Then Malcolm leaves Carney's employ and heads for semi-retirement in Bermuda, although we're told he still does some light trading.
That's not the whole of the story, of course. There are some characters -- including Ivy Leaguers, other than just Carney and Malcolm. In the days leading up to the Hang Seng trade, for example, we're introduced to "Vince Meyer" (another pseudonym, surely), described as "the top trader of one of the biggest American banks in Hong Kong" who gives Malcolm a crucial datum. Meyer is a Harvard grad.
There's also some raw sex, some hinted-at violence, one vividly described auto accident, and some romance to liven up the prose, for those who don't think that index arb traders sitting in front of computer screens throughout the working day is by itself a very exciting spectacle even if it is profitable.
Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.