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The F words: an irregular, irritating series of dictionary narratives

F stands for …*   

Financial system, that is already far too large and powerful. Former US president Eisenhower’s prescient warning about the rise of the Military/Industrial Complex would today be about the danger of the Military/Financial Complex instead. Finance has become too important to be left to financiers. Countries need financial systems that provide savings, credit, insurance and pensions, but limited and controlled lest other nations end up like Britain – a rentier society producing few real goods and services and where talent is sucked into unproductive finance. The UK politician Peter Mandelson rightly recognised that “we need fewer financial engineers and more real engineers.”

Free markets, of which there are none and should be none. Adam Smith’s hallowed name is called on to justify so-called free markets, yet he well understood that if left to their own devices, markets will ineluctably result in collusion and corruption. Markets are, as the US finance writer Richard Bookstaber argues, a “demon of our own design” and we must learn to manage and control them lest they distort society even further.

Fines, more of which should have been levied on Wall Street’s denizens, along with prison terms.  J P Morgan did eventually pay a fine of US$13.8 billion (a dollar for every year of the universe’s existence) but only after delaying it long enough to see many householders, the potential beneficiaries of these payments, go bankrupt.

FVA, a 'correction’ to the price of derivatives, is the latest piece of creative accounting from, you guessed it, J P Morgan. ‘Funding Valuation Adjustment’ is a fiddle none seem to understand and fewer respect. The Financial Times rightly called it “a new earnings-distorting acronym in an industry plagued with them.”

Fees, eternally problematic, and made more so by simplistic instructions such as “you should only worry about after-fee performance”. Though true, that finesses the fact that (base) fees are certain and controllable, while performance is uncertain and at best only partly controllable. Low signal/noise ratios and information asymmetry ensure that the quality of financial products and investment strategies cannot be assured. So, as with high-priced haute couture fashion, lower fees will be interpreted as signalling lower quality. Indeed, investment banks do put their fees up when demand falls … and it works.

Fashion, drives decisions in our industry and for the same reason it does in the rag trade, because paradoxically we like to be with the crowd and yet show that we are ahead of it. Hedge funds have yet to promote themselves as a fashion statement, but it will come to pass. Rely on Oscar Wilde to pithily capture another human absurdity, Fashion is a form of ugliness so intolerable we have to alter it every six months.”

Fixed income, technically and mathematically far more interesting than equities, yet before the 1990 movie The Bonfire of the Vanities made bond traders fashionable, bonds were boring and traded by eternally pessimistic nerds. This raises two intriguing (to me) inter-related questions. First, is the asset class, swamped as it is with derivatives, effectively immune to the corrosion of diseconomies of scale? Second, to what extent do the prognostications of investment management giants such as PIMCO and BlackRock actually influence the Fed’s decisions? About 20 years ago James Carville, an adviser to then president Clinton, said that he wanted to be re-incarnated not as the president but as “the bond market” so he could then “intimidate anybody.” (See Financial system.)

Fallacy, of composition is something that is frequently heard yet infrequently exposed. A common instance, much used by business leaders, is the assertion that “industry must cut costs” (code for reducing wages), which ignores how one firm’s costs are another’s revenues. So the net effect of such cuts is a weaker overall economy. Keynes’ paradox of thrift is of the same ilk: it is prudent for each person to be thrifty, yet if we all are “enterprise will surely fade”.

Fiddling, an identifiable, common source of failure for investment strategies. Generally, for most organisations and strategies, fiddling destroys value but can be fun and reassures our guardians that we’re doing something. In most other areas of human endeavour, activity is seen as the true path to adding value. Investing is uniquely different. Its default stance should be “don’t just do something, sit there.”

* F also stands for Fantasy, Fidelity, False, Funds, Fear, Failure, …

Click here to read Jack’s previous dictionary article ‘The C words’ in Cuffelinks on 8 August 2013.

Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing.


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