Barometer of Fear

by Alexis; Stenfors

  T-bills are securities that expire within a year and are issued by governments, whereas bonds refer to papers with longer maturities. Mortgage bonds are securities issued by institutions involved in mortgage lending. Considering the small size of the country, the Swedish fixed-income market (the common name for these products) was enormous. The government had borrowed a lot for an extended period of time and therefore had accumulated substantial debts. These debts could be traded in the market as securities, and this is precisely what we did.

  The dealing room was minuscule compared with the one I had seen in Frankfurt, containing no more than 15 or 20 seats. In fact, it looked more like a gentlemen’s club than a bank: high ceilings, expensive oak floors, chandeliers and only a discreet sign outside revealing the nature of the business conducted by Midland Montagu on Birger Jarlsgatan in Stockholm.

  My training programme, which took place on day 2 and day 3 of my employment, looked like this:

  Tuesday

  09.30 IT

  10.30 Credit and Risk

  13.00 Finance Department

  14.00 Back Office

  15.00 Equity Department

  16.00 Management

  Wednesday

  09.30 Human Resources

  10.30 Corporate Banking

  On day 4 (having successfully completed my training course in less than 48 hours), the time was ripe to learn how to become a trader. It turned out that just a few weeks before I joined, Swedbank (a large Swedish bank) had poached every trader but one from Midland Montagu. The situation was a bit uncertain to say the least, and the junior trader who had decided to stay was catapulted into the position of acting chief dealer. The sales person with whom I was supposed to work suddenly became assistant trader. This was neither the time nor the place for me to be trained as a sales person looking after clients. The pecking order was made clear to me. A sales person could be sacrificed for a trader, but never the other way round.

  The chief economist took charge of the training. An odd choice perhaps, but he was very respected in the dealing room and also happened to know the ins and outs of trading. It was old school. The junior economist, who was the other new recruit alongside myself, and I were told to stay in the dealing room for an hour after work one evening. The session was about learning how to master the technique of using two ears, two hands and two telephones to call two banks at the same time.

  The chief dealer might have to buy 500 million T-bills from the other market makers to cover a client trade. As the dozen or so banks and brokerage firms quoting Swedish T-bills did so only in tickets of 50 million, we would need to deal with ten of them. The task therefore required five people. The chief dealer would tell the five traders to call out on, say, the ‘December T-bill’ (a debt obligation issued by the Swedish government maturing in December). We would then each press the speed dial to the two banks that were designated to us and ask for a two-way price on the December T-bill. One by one, the banks would quote a price at which they would buy (a ‘bid’) and at which they would sell (an ‘offer’) 50 million. One by one, these prices would be shouted across the dealing room to the chief dealer, who would then decide what to do and would shout back ‘Mine!’, ‘Yours!’ or ‘Thanks, but nothing there!’ We would then immediately repeat ‘Mine!’, ‘Yours!’ or ‘Thanks, but nothing there!’ to the person on the other line.

  Clients were referred to as market or price ‘takers’, referring to how they approached the market place. We and our competitors, on the other hand, were market or price ‘makers’, as we quoted the prices they could trade at. One of the key requirements to becoming a member of the market-making club was that you always had to quote two-way prices to the other club members: a bid and an offer at the same time. A gentlemen’s agreement also dictated that you had only a few seconds to decide what to do. Otherwise, the person on the other line would shout ‘Risk!’ This meant that you could no longer deal based on the stated price and would need to ask again. If, however, you had dealt on a price, you had the right to ask the same bank for another price before they hung up. In this case, the unwritten rule stated that you should ask: ‘Next price, please?’

  It reminded me of the games we used to play after school when I was a child, where a series of strict rules were solemnly announced ahead of play by the older and more experienced children. As a beginner you would never ask why and how these rules had been invented, or by whom. And when a new player arrived, you recited the rule book as if it were the most natural thing in the world. You did not break the unwritten rules, nor did you ask why they existed.

  A ‘call-out’ was very quick, exciting, loud and sometimes quite chaotic. A large client trade or a choppy market resulted in a large number of trade tickets with different banks in different amounts and at different prices. This invariably meant even more market movement. As soon as we hung up the phone to the other banks, they were already calling us on the other lines because their traders had been commanded to press their speed dials to demand prices from us.

  An attack led to retaliation, and sometimes it felt like we were foot soldiers repeatedly sent out on missions to shoot at each other. I don’t remember if I ever got to meet the two traders who were responsible for picking up the phone at Aragon and Aros, the two brokerage firms behind the enemy line designated to me. However, after thousands of phone calls, hostility was gradually complemented by sympathy and mutual respect. Our loyalty was shared between the bank we worked for, the market we traded in, and the rules of the game. And just as your closest colleague was not always your best friend, your fiercest competitor was not always your worst enemy.

  Sometimes call-outs were made for no particular reason, or simply to check the barometer. A string of low prices would indicate that banks were keener to sell than to buy. High prices hinted the opposite. Call-outs were also made to hear the voice of a competing trader. Did he or she sound relaxed, stressed or perhaps nervous about something? Or to listen to the noise levels in the other dealing rooms across the city. What were they up to?

  As a result, clients had to be given nicknames in case an incoming caller might accidentally snap up some confidential information. A large construction company might be renamed ‘The Screw’ or a car manufacturer ‘The Shark’ (perhaps referring to the copious amounts of hair gel the customer used). These codenames were then changed regularly in order to protect trade secrets and clients’ identities. Traders, too, were given nicknames. Paradoxically, such nicknames later came to be used in order to reveal, rather than protect, identities that were supposed to remain secret.

  A trader’s ‘book’ would consist of all the trades a trader had in his or her portfolio. A trader’s ‘position’ was then a general term for how sensitive this book was to different price movements in the market. This sensitivity would normally be expressed in the amount made or lost if the market moved by one basis point (0.01 per cent). A ‘long position’ meant that money would be made if prices in the market went up, and a ‘short position’ was the opposite. The chief dealer had an assistant keeping track of the positions. It was, of course, necessary to know whether you had accidentally bought too little or too much. You did not want to find out that 50 million T-bills were missing when the market closed for the day. Who knew how much they would cost tomorrow?

  When the market was volatile, mistakes happened rather frequently. Simply the fear of a possible mistake could lead to irritation and heated conversations. As all phone conversations were recorded, junior traders were often sent out to listen to the tapes of each individual call. It goes without saying that, with the phones bugged, you tried to keep your private life relatively private when you were in the dealing room. Beyond this, nosiness and gossip outside the dealing room were generally frowned upon. Perhaps the collective feeling of constantly being observed led traders to accept and tolerate each other’s vulnerabilities. Although the dealing room banter could be raw and unfiltered, it was supposed to be kept secret from ‘others’. This naturally stre
ngthened the feeling of ‘us versus them’, ‘them’ being pretty much everyone who wasn’t a trader (or maybe a sales person or broker).

  ***

  My life as a trader was shaped to some extent by the transformation of the banks I worked for. Midland Montagu became Midland Bank Stockholm Branch and we moved to a new dealing room. Soon afterwards, new business cards had to be printed as we adopted the HSBC brand. Within two years, we had developed from a boutique merchant bank into an integral part of an ambitious global banking giant. We, as the tentacle in the Nordic region, would now serve clients not only by quoting prices in bills and bonds, but also in FX and interest rate derivative instruments. Tomas was brought in from Hong Kong to run the dealing room, and extra expertise was flown in from London. A small army of traders and sales people was hired, mostly from Nordbanken, which had been nationalised following the Swedish banking crisis.

  I became part of the treasury desk, sitting bang in the middle of the trading floor. Surrounded by the bond and FX spot traders and their respective sales forces, our job was to take care of the funding of the operation as well as to trade a range of money market instruments. Uffe and Toby were experienced FX swap traders and took charge of the risk-taking activities, whereas Erik sorted out the funding of the bank. My job was to look out for arbitrage opportunities in the FX, money and derivatives markets. Basically, it was about mathematically working out – and, as the market moved, continuously recalculating – how to borrow at the lowest possible rate or to lend at the highest. It had taken some time for the derivatives market to establish itself in Scandinavia. Senior traders still talked about the ‘yuppie tax’, a financial transaction tax; although it had since been abolished, this had completely wiped out the derivatives market during the late 1980s. But the derivatives market was now booming again. Since the Nordic countries had introduced their own LIBORs (Stockholm Interbank Offered Rate (STIBOR), Helsinki Interbank Offered Rate (HELIBOR), Norwegian Interbank Offered Rate (NIBOR) and Copenhagen Interbank Offered Rate (CIBOR)), I now had the opportunity to trade the instruments I had only seen on paper in Frankfurt a couple of years before.

  As was the case for most other short-term interest rate traders, understanding and trying to accurately predict the various LIBORs were central parts of the job. They had become the key benchmarks for instruments used to hedge and speculate in the money markets. Corporations, pension funds and insurance companies had real hedging requirements that were met by quoting them appropriate LIBOR-indexed derivatives. The instruments therefore served their original purpose, namely as tools to eliminate risk – or at least to reduce it. Banks, on the other hand (but also some treasury departments of large multinational corporations), preferred to use them for speculative purposes. For instance, if traders believed that the market was underestimating the probability that the central bank would raise the interest rate soon, they would simply buy a forward rate agreement (FRA). A FRA was a derivative contract that enabled you to protect yourself from, or profit from, interest rate movements in the future. If, for instance, the central bank took people by surprise and raised the interest rate, the price of the FRA would rise in line with the now higher interest rate and a profit could be booked. Or vice versa.

  The structure of the FX and derivatives market seemed much more sophisticated and internationally oriented than that for Swedish bonds and T-bills. Instead of old-fashioned telephones, we used Reuters Dealing 2000-2 to communicate and trade with other banks. It was high-tech at the time, a kind of two-person electronic chatroom that predated the internet. Each trading desk at each bank had a four-letter identifying code, and you simply needed to type the code and hit the send button on the custom-made keyboard and then a beeping sound would signal an incoming call at the other end. We opted for ‘MIST’, referring to Midland Stockholm, but also because it was memorable and sounded cool.

  You could call four banks in one go, meaning that you could trade more, and faster. A young FX spot trader sitting opposite me was even able to use two machines at the same time, enabling her to talk to eight competitors simultaneously. I was impressed and became determined to learn her skill. In the end, I did.

  Then, one night, I got a call from a person claiming to be a headhunter. He asked me whether I wanted to move to London and work for Citibank. Initially I thought it was a prank call. Citibank had the biggest and most professional FX operation in the world, and the trading floor in London was the heart of it. I was young and inexperienced.

  But it was for real. I flew to London, had interviews, and they offered me the job. When I asked my girlfriend Maria whether she wanted to come along, she simply asked: ‘What shall I bring?’

  ‘Bring everything,’ I answered.

  ***

  At Citibank, I joined the Short-term Interest Rate Trading (STIRT) desk, where we acted as market makers in a range of FX and interest rate derivative instruments in all currencies that were not classified as ‘emerging markets’. Upon arrival, I was given responsibility for the small Finnish trading book and acted as a back-up trader in the Nordic currencies, the Japanese yen and the Canadian dollar. I was also, like everybody else, trading US dollars. Nobody else wanted the Finnish book, as it had never been a money-spinner. The sales people in our Nordic bank branches demanded quick and competitive prices, and unless you were on top of the game, it was going to end in tears. I remember a senior trader looking at me gleefully when it was announced that I had formally taken over the hopeless task. But it suited me perfectly. I got along well with the sales people, and they had impressive client lists covering most of the large domestic corporations and institutions.

  Apart from not having to cross any cultural or language barriers, it also turned out that we had a clever desk setup. At the time, being able to trade a range of different financial instruments on a STIRT desk such as ours was a rather novel invention. Apart from Chemical Bank (which later became Chase Manhattan and then JPMorgan Chase) and maybe a few others, virtually all major banks still separated their FX trading desks from their interest rate derivatives activities. The Nordic banks did likewise. To me, this separation did not make any sense. FX swaps (which I traded) were contracts with which you bought one currency against another, and simultaneously did the opposite on a predetermined date and at a predetermined price in the future. For instance, you could buy $100 million against Japanese yen now and agree to sell them back in a year’s time. The FX swap price was the difference between the future price (the FX forward price) and the current price (the FX spot price). Theoretically, however, the FX swap price could also be seen as the difference in interest rates in two currencies. Imagine you bought a car for $10,000 and simultaneously agreed to sell it back to the car dealer at $9,000 a year later. This could be seen as having bought and sold a car. However, it could also be seen as having borrowed a car and simultaneously lent money for one year. As FX swaps involved money in one currency versus money in another currency, the prices simply captured the cost of borrowing in one currency versus lending in another.

  If the price differed from this theoretical price, someone would jump in to do arbitrage, effectively buying one thing cheaply and selling the same thing expensively at the same time. We and a few other banks were in a perfect position to benefit from such opportunities in the FX and interest rate markets, and this edge could also be turned into more competitive prices quoted to the sales people and their clients.

  ***

  As my formative trading years had been spent in Scandinavia during the early 1990s, the Scandinavian banking crisis and the crisis of the European Exchange Rate Mechanism (ERM) had had a strong and lasting impact on me. Everyone I worked with had stories to tell, each one more remarkable than the last. Experienced traders often said that your early trading years were important, that they shaped the way you looked at the world – for instance, whether you became an eternal optimist (a bull) or an eternal pessimist (a bear). The person who influenced me the most as a trader was my boss at HSBC Stockholm. U
ffe was certainly not the most technical person I knew – he had scribbled ‘Ctrl+Alt+Del’ on a yellow Post-it note to remind himself what to do if his computer crashed in the middle of a hectic trading day. He called it the ‘all-to-hell button’, and the keyboard sequence was pressed very often. Despite this, Uffe had the rare ability to read the market like an open book. He could sense when things were about to go wrong, almost ‘feel’ when other traders were beginning to become afraid. An instinct that was quicker than any other person or computer algorithm. I was very lucky to be seated next to him and Toby, a close colleague who joined him from Nordbanken. Sources claimed that he had made over 1 billion Swedish kronor for his bank by trading foreign exchange in 1992 – a staggering amount of money back then, but also in today’s money. It was the same year when speculators had begun to doubt the sustainability of the fixed exchange rate regime, and then successfully bet against it. George Soros had famously ‘kicked the pound out of the ERM’. Sweden had also been among the victims, having been forced to raise interest rates to an astonishing 500 per cent. Rumours, however, also suggested that Uffe had assisted the central bank during the crisis, by ‘policing’ the market and informing the policy makers of who was betting against their currency. He was an active trade union member (a rarity among foreign exchange traders) and apparently his bonus during that remarkable trading year had been precisely zero. I didn’t know if these rumours were true, and I didn’t care. I liked Uffe. He was a bear and so was I. Financial crises were inevitable and always around the corner when people least expected them. Stock markets would crash. Currencies would collapse. Interest rates would soar.