ET Note: The Life Aquatic

My latest for Epsilon Theory is about surviving and thriving in a highly financialized world. What’s financialization?

Financialization is all about using financial engineering techniques, either securitization or borrowing, to transfer risk. More specifically, financialization is about the systematic engineering of Heads I Win, Tails You Lose (HIWTYL) payoff structures.

In business, and especially in finance, we see this playing out everywhere.

Debt-financed share buybacks? HIWTYL.

Highly-leveraged, dropdown yieldcos? HIWTYL.

Options strategies that systematically sell tail risk for (shudder) “income”? HIWTYL.

Management fee plus carry fee structures? HIWTYL.

Literally every legal doc ever written for a fund? HIWTYL.

There are two ways to effectively handle a counterparty that has engineered a HIWTYL game: 1) refuse to play the game at all, 2) play the game only if you have some ability to retaliate if your counterpaty screws you. Legal action doesn’t count. The docs and disclosures are written to be HIWTYL, remember?

(aside: corporate borrowing can be viewed as management selling put options on a company’s assets. I’ll leave it to you to consider what that might imply about government borrowing)

You need to be in a position to hurt your counterparty for real.

You need to be in a position to hurt your counterparty economically.

A friend (who is not in finance) recently asked me about the relationship between the sell-side and the buy-side. His question was basically this: is the purpose of investment banking just to rip fee revenue out of people by whatever means necessary even if it involves deliberately misleading them to screw them over?

My answer is that the sell-side’s purpose is simply to facilitate transactions. For investment bankers, that means raising capital or advising on M&A deals or whatever. For sell-side research groups it means driving buy and sell transactions.

The sell-side does not exist to make you money.

You can do business with the sell-side. You can even respect the sell-side. But you should never trust the sell-side. The same goes for pretty much all business relationships. Especially transactional relationships.

We poke fun at the sell-side around here, but what we’re poking fun at is just the sell-side’s Buddha nature. The zen master Shunryu Suzuki described Buddha nature thusly:

“If something exists, it has its own true nature, its Buddha nature. In the Parinirvana Sutra Buddha says, “Everything has a Buddha nature,” but Dogen reads it in this way: “Everything is Buddha nature.” There is a difference. If you say, “Everything has Buddha nature,” it means Buddha nature is in each existence, so Buddha nature and each existence are different. But when you say, “Everything is Buddha nature,” it means everything is Buddha nature itself.”

If that’s a bit too inscrutable for your taste, consider the fable of the scorpion and the frog:

A scorpion asks a frog to carry it across a river. The frog hesitates, afraid of being stung by the scorpion, but the scorpion argues that if it did that, they would both drown. The frog considers this argument sensible and agrees to transport the scorpion. The scorpion climbs onto the frog’s back and the frog begins to swim, but midway across the river, the scorpion stings the frog, dooming them both. The dying frog asks the scorpion why it stung the frog, to which the scorpion replies “I couldn’t help it. It’s in my nature.”