Taking the Floor

Models, Morals, and Management in a Wall Street Trading Room

Daniel Beunza

• Publisher: Princeton University Press
• Year: 2019
• Print ISBN: 9780691204772, 9780691162812
• eBook ISBN: 9780691185996
• Topic: Social Sciences
• Subtopic: Financial Services
• Index: Social Sciences

An inside look at a Wall Street trading room and what this reveals about today's financial system

Debates about financial reform have led to the recognition that a healthy financial system doesn't depend solely on how it is structured—organizational culture matters as well. Based on extensive research in a Wall Street derivatives-trading room, Taking the Floor considers how the culture of financial organizations might change in order for them to remain healthy, even in times of crises. In particular, Daniel Beunza explores how the extensive use of financial models and trading technologies over the recent decades has exerted a far-ranging and troubling influence on Wall Street. How have models reshaped financial markets? How have models altered moral behavior in organizations?

Beunza takes readers behind the scenes in a bank unit that, within its firm, is widely perceived to be "a class act," and he considers how this trading room unit might serve as a blueprint solution for the ills of Wall Street's unsustainable culture. Beunza demonstrates that the integration of traders across desks reduces the danger of blind spots created by models. Warning against the risk of moral disengagement posed by the use of models, he also contends that such disengagement could be avoided by instituting moral norms and social relations.

Providing a unique perspective on a complex subject, Taking the Floor profiles what an effective, responsible trading room can and should look like.

1

Introduction

Whether in the form of toxic derivatives or fake Libor submissions, the growing list of financial misdeeds that emerged from Wall Street since the beginning of the global financial crisis has fueled a decade-long debate about financial reform. Consider, for instance, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, often described as the most significant change to financial regulation in the United States since the 1930s. Opponents of Dodd-Frank object to its excessive rigidity, arguing that it will starve US companies of the necessary capital. Proponents of stricter regulation, on the other hand, fault Dodd-Frank for its limited effectiveness, pointing to the continued problem of the too-big-to-fail banks. While resolution of this debate remains elusive, one intriguing outcome of the discussions has been the recognition that the moral standards on Wall Street, and not simply the standards set by the law, are critical to a healthy financial system. For instance, the National Commission on the Causes of the Financial and Economic Crisis concluded in 2011 that “there was a systematic breakdown in accountability and ethics,” adding that this erosion of standards of responsibility and ethics “exacerbated the financial crisis.”¹

Concern about ethics underlies a visible shift in financial regulation within the United States and United Kingdom. In the United States, the initial regulatory response to the crisis took the form of structural reform, based on laws, rules, and prohibitions. This was exemplified by the Volcker Rule and its stipulated ban on proprietary trading in commercial banks. Subsequent efforts by American regulators, however, shifted to the norms and values in Wall Street banks. For instance, in October 2014, the president of the New York Federal Reserve, William Dudley, organized the Workshop on Reforming Culture and Behavior in the Financial Services Industry, including among its attendees the chief executives of major Wall Street banks. In his opening speech, Dudley announced that “improving culture in the financial services industry is an imperative.”² Using the word “culture” as many as forty-five times, Dudley emphasized its inescapable presence and importance: “culture,” he remarked, “exists within every firm, whether it is recognized or ignored, whether it is nurtured or neglected, and whether it is embraced or disavowed.”

A similar shift has taken place in the UK. Shortly after the financial crisis, the Independent Commission on Banking Report of 2011 took a structural approach to reform, issuing recommendations to “ring-fence,” or legally separate, the retail and investment arms of British banks. In subsequent years, however, the emphasis turned to culture. The Salz Review of Barclays Bank, published in 2013 after the Libor scandal, concluded that “bankers were engulfed in a culture of ‘edginess’ and a ‘winning at all costs’ attitude,” adding that these traits contributed to the bank’s malpractices.³ The Kay Review, commissioned by the British government to address short-termism in the City, found that “a culture of trust relationships, which is actually central to making financial services work, has been displaced by essentially a culture of transactions and trading.”⁴ The bank culture agenda culminated in the creation of the UK Banking Standards Board in 2015, an organization that aims to “raise standards of behavior and competence across the [financial] industry.”

What emerges from these developments is a novel approach to financial reform, ostensibly aimed at bank culture but substantively centered on morality in the financial industry. Indeed, when a journalist pressed Dudley to specify what he meant by reforming culture, his response was that “culture is too broad a way to describe this. I think, reflecting on it, it’s really about ethics and conduct.”⁵ The bank culture agenda thus stands in contrast with the traditional regulatory emphasis on outlawing misconduct and aligning incentives. Moral norms, unlike laws or incentives, do not speak to interests, but to underlying assumptions, prevailing customs, and the institutionalized definitions of right and wrong. By underscoring the moral dimension of markets, the new approach equates to an implicit admission that no amount of tinkering with bonuses or legal rules can, in the absence of ethical change, address the shortcomings of the financial industry.

Predictably, the culture agenda has been met with skepticism among Wall Street executives. Some have objected that culture is too vague a concept to prove effective, while others have added that culture lacks practical and actionable implications. The bankers’ resistance was poignantly captured by the words of the US Comptroller of the Currency, Thomas J. Curry, who was tasked with the unenviable job of listening to the bankers’ complaints. “I’ve had some bank executives and directors say, ‘I’m not a damn sociologist,’ ” Curry explained to a reporter from the Wall Street Journal.⁶

Disparagement aside, the bankers’ response is remarkable for its accurate reflection on disciplinary expertise. Ever since Max Weber’s study of the Protestant work ethic, sociologists have claimed for their own discipline the problem of how culture shapes the economy. In Weber’s case, the celebrated German sociologist first hypothesized a connection between moral beliefs and economic development. “Calvinist believers were psychologically isolated,” Weber famously wrote, adding that “their distance from God could only be precariously bridged, and their inner tensions only partially relieved, by unstinting, purposeful labor.” Once material success came to be seen as a sign of God’s favor, people were free to engage in trade and accumulation of wealth, and capitalism grew and expanded in Northern Europe. Weber’s approach was central to sociology for much of the twentieth century, bolstered by the view—subsequently developed by the midcentury sociologist Talcott Parsons—that society is held together by shared values and “moral consensus.”⁷ In Parsons’s formulation, moral norms and values are the central guide of action. Situations provide the means and conditions of action, values motivate the pursuit of certain ends rather than others, and norms limit the choice of the means to achieve those ends.

Over the past decades, however, Parsons’s formulation has come under attack from contemporary sociologists, culminating in an alternative perspective of culture centered on practice. The alternative is chiefly associated with the work of Ann Swidler, who disputed the Parsonian contention that values are the key link between culture and action. A values-based account, Swidler argued, overlooks the fact that people may share common aspirations while remaining widely different in their behavior. For instance, explaining the absence of economic achievement by the urban poor in terms of a “culture of poverty” presupposes that the poor do not share the values and aspirations of the middle class, but working-class youth surveys repeatedly report that they value middle-class aspirations such as education, secure friendships, stable marriages, and steady jobs.

Instead of shaping action through internalized norms and values, Swidler added, culture influences action by creating a set of cultural competences that allow people to achieve some ends and not others. After all, one can hardly pursue success in a world where the accepted skills, style, and informal know-how are unfamiliar. Returning to the culture of poverty debate, Swidler wrote that “if one asked a slum youth why he did not take steps to pursue a middle-class path to success, the answer might well be not ‘I don’t want that life’ but instead, ‘Who, me?’ ” Lack of familiarity with an environment, in other words, is a roadblock to success. Swidler adds that culture influences action not by providing the ultimate values toward which action is oriented, but by “shaping a repertoire or toolkit of habits, skills, and styles from which people construct strategies of action.” Swidler’s emphasis on practice, often referred to as the “toolkit” perspective, stands in clear contrast to Parsons’s view of culture as values. “Action is not determined by one’s values,” Swidler concludes. “Rather, action and values are organized to take advantage of cultural competences.”⁸

Taken together, the positions adopted by the bankers, regulators, and sociologists discussed so far suggests a peculiar landscape of intellectual alliances. Although sociologists have steered clear of Parsons’s emphasis on shared norms and values, the latter has resurfaced in economic reports and reviews of the crisis, a phenomenon that is apparent in characterizations of banks in terms of a “culture of edginess,” or a “culture of transactions and trading.” A similar take on culture is found among academic economists. Thus, a well-known economic study by Luigi Guiso, Paola Sapienza, and Luigi Zingales equated culture with values, drawing from survey data on “how values are perceived by employees.”⁹ Similarly, Andrew Lo has proposed the existence of a “Gordon Gekko” effect in financial organizations (making reference to the infamous Hollywood villain) whereby “an epidemic of shared values” can lead to excessive risk-taking.¹⁰ Culture is presented by Lo as an all-encompassing determinant of behavior. As with a nasty virus, once an organization catches the wrong sort of culture, there is little that their members can do. At the risk of oversimplifying, one is tempted to conclude that the global financial crisis has posthumously granted Parsons his much-desired wish for intellectual influence over economists.

Paradoxical as the above might sound, the alternative is no less surprising. Skepticism toward the cultural reform program on Wall Street, certainly in its values-based version, includes sociological followers of Swidler as well as bank executives who resist the supervisory expansion of the Federal Reserve. This is admittedly not a real coalition, for the said sociologists are chiefly opposed to Parsons, while the bankers are simply against additional rules. Indeed, this would not even be a happy coalition, for as we learned from Thomas Curry, bankers are keen not to be taken for sociologists. Nevertheless, it is not too much of a stretch to argue that opposition to the vagueness and ineffectiveness of a values-based cultural reform places academic supporters of Swidler and profit-minded Wall Street executives in the same intellectual camp.

The post-crisis debate, in sum, seems to have bred some unusual travel companions. The odd pairings are revealing of the depth with which financial devastation in 2008 has shaken up the intellectual foundations that traditionally sustained the financial industry. The idea, central to financial economics, that morality can be analytically extricated from the study of finance, has been thoroughly called into question by the official reports and reviews of the crisis. The study of finance, these reports emphasize, should be broadened beyond approaches that omit references to ethical dilemmas. They should incorporate, as Maureen O’Hara has written, “more focus on ethical issues in finance.”¹¹ The same conclusion applies to the practice of bank supervision: whereas regulators traditionally entrusted the elimination of misconduct on Wall Street to the care of the legal system, they now favor an approach that targets the bankers’ ethics directly.

There is, in sum, an emerging consensus that if financial reform is to make progress, morality needs to be brought back into finance, both in practice and the study of finance. Yet, given the sociological arguments noted above, moving beyond well-intended but often ineffective interventions on bank values calls for answers to two pending questions. The first concerns the moral diagnosis of the crisis: if not through overly materialistic values such as greed or impatience, how exactly did morality contribute to the banks’ troubles? Put differently, once one abandons the enticing but ultimately unsatisfactory idea that bankers have fundamentally different morality than the rest of people in society, the moral drivers of the crisis suddenly become obscured. The challenge then, as with the analyses of underachievement among the urban poor, is to formulate an understanding of what went morally wrong on Wall Street that does not caricature bankers as Hollywood villains. A second pending question concerns the prognosis for financial reform: if presenting bank employees with a brand-new set of values—much in the way that they might be given a new corporate uniform—is unlikely to alter their actions, what type of reform might avoid a repetition of the problems that led to the crisis? That is, if moral interventions solely centered on values are unlikely to do the trick, what form of cultural change will?

A partial answer to these two questions can arguably be found in the literature on morals and markets associated with Viviana Zelizer. The work of this influential sociologist has systematically explored the ways in which morality enables and legitimizes the development of otherwise controversial market transactions. For instance, her seminal study of life insurance in the early nineteenth century showed that insurers had to grapple with the moral resistance of their potential customers, American wives, who objected to profiting from a husband’s hypothetical death.¹² Their qualms were only overcome when insurers reframed their product as compensation for economic rather than affective loss, presented insurance as a form of preserving the welfare of orphan children, or claimed that insurance was a way of avoiding the indignity of a pauper’s burial. Zelizer’s analysis thus suggests that morally ambiguous markets can be made viable if the necessary frames and practices are put in place. In a similar vein, Michel Anteby has documented how adherence to certain practices makes commerce in human cadavers for medical research morally acceptable.¹³ He found that buying and selling of such specimens for research purposes is nowadays deemed satisfactory if it is not for profit, if it has the doctor’s consent (not only that of the family), and if the cadavers are kept whole rather than cut into pieces. In sum, and as Marion Fourcade and Kieran Healy have observed, markets can be seen as “moral projects,” that is, enabled and made possible by arrangements that create moral boundaries and draw moral distinctions between the sacred and the profane.¹⁴

While insightful, the morals and markets literature has not yet offered specific prescriptions for financial reform, nor engaged financial markets. In this regard, one promising point of departure is the sociological literature on finance. One of the early contributors to this literature, Mitchel Abolafia, paid special attention to the institutional mechanisms that create restraint. Building on a comparison across three financial settings (bond traders in a bank, pit traders in a commodities exchange, and specialists at the New York Stock Exchange), Abolafia challenged the argument that a trading culture inevitably leads financiers down the path of opportunism, as a Parsonian analysis would contend. He argued instead that restraint can be instilled through the “norms, rules and procedures to which members of the trading community are habituated.”¹⁵ For instance, he argued that the Treasury bill auction scandal of 1991 that brought down Salomon Brothers was the result of an environment, constructed by the investment banks in the 1980s, “with minimal interdependence, extraordinary incentives for self-interest, and minimal constraints on behavior.” It was the lack of restraint created by such structures, Abolafia argues, rather than opportunistic moral values, that led bankers to withhold information from clients, post false bids in trading platforms, or front-run customers.¹⁶

There is one sense, however, in which Abolafia’s account is of limited relevance to the debate about financial reform. Over the past four decades, Wall Street has been reshaped by the adoption of economic models, electronic trading, and derivative instruments, to the point of undergoing what some have described as a “quantitative revolution.” Yet, partly because of the time in which Abolafia’s fieldwork was conducted (the early 1980s), his analysis does not engage wit...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Dedication
• Contents
• Acknowledgments
• 1. Introduction
• 2. First Impressions
• 3. Trading Robots and Social Cues
• 4. Animating the Market
• 5. Models and Reflexivity
• 6. Managers
• 7. Performative Spirals
• 8. Norms
• 9. Resonance
• 10. The Global Financial Crisis
• 11. Scandal
• 12. When All Is Said and Done
• 13. Conclusion
• Methodological Note
• Notes
• Bibliography
• Index
• A Note on the Type