A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation

CHAPTER 2

THE DEMONS OF ’87

When I got there in the summer of 1984, Morgan Stanley was still the exclusive partnership it had been since its inception in 1935. The firm’s investment bankers lorded over that sexy part of the business, but I was headed for the fixed income division—bonds. You couldn’t get less glamorous than fixed income—unless, of course, you worked in fixed income research (FIR), which is exactly where I would spend my first years on Wall Street.

Bob Platt wanted to change all that. A former midlevel insurance executive, he had been snatched from obscurity to run Morgan Stanley’s fixed income research division. Obscurity in this case was the giant institutional machine called the Equitable Life Insurance Company, headquartered at 52nd Street and Seventh Avenue, not far from Morgan Stanley’s offices at 50th Street and Sixth. When Bob arrived at Morgan Stanley in 1982, the fixed income domain was still just a step or two removed from the backwater of green-eyeshaded bookkeepers, ledgers stacked on their Steelcase desks, tracking bond coupon payments.

This world of fixed income, however, would soon become the vanguard of a revolution made possible by mathematics. At regular intervals the U.S. government issues bonds of varying maturities, from 30 days up to 30 years, with the longer-term bonds typically yielding higher interest rates than the shorter-term ones, to reflect the risk of having your money tied up longer. Plotting these payouts forms the well-known yield ...