Risk and reward: A tale of high finance in the High Sierra
August 14, 2012
The first time lightning struck the hillside above us, I felt a tear in the fabric of my self-confidence. The next hit pealed down my spine, ignited the butterflies in my stomach. Then another. Ripping the air. Breathless. The smell of burning. What had been a sense of sublimity minutes before gave way to raw, primordial fear. Cold fear. And the hits kept coming. Like heavy artillery. All light and noise and wind and wetness lashing us. Punishing us for our decision, my decision. Just how we’d gotten stuck at 11,000 feet in the summer’s worst storm was, at that moment, not clearly perceived, not clearly delineated, as each step of our journey would be in the days to come.
It began with a conversation about financial risk. My younger brother was leaving for New York City to pursue a graduate degree in financial engineering, and my father and I had decided to take him backpacking in the Sierra one last time before the East Coast got its upscale claws into him.
The night before our trip, Aug. 3, we stayed up drinking Scotch and discussing current affairs of the world. He shared with me his growing knowledge of behavioral economics, how many very smart people have taken advantage of our own irrationality. The “Quants,” as they’re called, hail from Ivy-league universities, have advanced degrees in mathematics and physics, and make millions of dollars monitoring the markets. They create complex algorithms and use computer modeling to catch every little dip, spike and hiccup within the trading day. Imagine a seismograph recording a swarm of earthquakes. In a similar way, the Quants have set up automated systems that detect market trends and execute trades accordingly. They’re able to get out front of any surge, or, conversely, cut losses before a plummet.
“There was a Quant firm in Georgia that had to move back to New York because they weren’t executing trades fast enough,” my brother told me.
That particular firm’s trading network relied on fiber-optic cable, he said. In other words, the speed of light was not fast enough.
You may be wondering what’s wrong with a bunch of brainiacs devising algorithms to play the market. Nothing. Unless you believe what many in high finance believe – that such automated, high-frequency trading contributed to the “Flash Crash” in May 2010, when the Dow Jones Industrial Average dropped 1,000 points in a matter of minutes. Nothing. Unless you acknowledge that other people’s money, other people’s livelihood, was entangled in their machinations. A glitch, a trigger, a panic-sell. Nothing. Unless you believe that these firms are distorting the risk-reward relationship that has driven material progress for centuries, that there is something inherently wrong when little risk leads to big reward, especially at the expense of others.
Of course, these are rhetorical questions. My father, my brother and I headed south for Tioga Pass on the morning of Aug. 4. My father had a new backpacking tent he was excited to use. It was literally brand new. Still in the box. In Bridgeport, we rented a bear canister for our food. The Saw Tooth Ridge above Twin Lakes showed like a sharp, insurmountable divide between choice and consequence. By Conway Summit, we had struck up a conversation about JP Morgan Chase’s massive, multibillion losses earlier in the year. My brother explained that it was a hedge gone bad. A few distinguished individuals had made a derivatives deal that doubled exposure to corporate bonds rather than insuring against losses. The bad decision put the bank’s depositors, its shareholders, and, quite possibly, the financial system at risk.
A good definition of a derivative is rare in the press, and I don’t intend to provide an extensive one here. It’s safe to call it a financial instrument that derives value from some underlying asset in the market depending on how that asset behaves. Apparently, they are so complex that top-level traders don’t know what value they’re getting. Not unlike Quant funds that leach off primary movers in the market, the problem with some derivatives seems to be a few individuals or companies risking other people’s money in ways those people didn’t intend.
Our conversation moved to the Libor scandal last month, when London banks were caught fixing the interest rate of their interbank loans, which in turn affects interest rates everywhere. No bank wanted to be seen with a higher rate, my brother said, even if market realities necessitated one. Fear of negative publicity bonded top managers in collusion.
So here it is. Four years after the economy tanked. Four years after risky mortgage-backed securities, which had been rated safe, infected the whole financial system. Four years later, and the big banks appear to be throwing caution to the wind. Four years later, and it’s still hard to tell the difference between a commercial bank and a hedge fund. Following the most recent scandals, some CEOs have promised to back off any investment considered more than conservative. But we’ve been told this before. My brother, well-versed in risk management, is skeptical. He was skeptical that morning driving toward the mountains. Financiers won’t settle for less profit when they can get more. Human beings won’t settle for the hearth when they can reach out and touch the fire.
Mono Lake lay like a mirror on the desert floor, reflecting the mountains above Lee Vining. The ramparts broke from the basin at such steep angles that the whole range seemed to be lifting off. At the lake’s visitors center, we pulled our overnight permit for the Hoover Wilderness. The young, soft-voiced ranger told us that only 25 permits, out of a quota of 200, were pulled for the weekend. She then relayed the weather forecast for Tioga Pass. Thunderstorms expected by 11 p.m. Cooler temperatures, lightning, rain. At that moment, there might have been a flash of warning in her face, but I didn’t see it. She resumed her work. She listed the perfunctory rules and advisories and wished us good luck. It would take more than a rainstorm to thwart us. Camping in wet weather was not unusual for three guys who’d grown up in the mountains.
At the trailhead at Saddlebag Lake, we went through our supplies. Food and water. Check. Campstove. Check. Matches. Check. First aid, bear spray, sunscreen, bug repellent. Quadruple check. Dry clothes. Check. Rain ponchos. Check. Headlamps. Check. I hefted my father’s new tent. It was surprisingly light and agile. Designed for the best backpackers, I assumed. I cut the seal and removed the sack inside, again remarking on its lightness. I tightened the drawstring and strapped the thing to my pack.
The skies darkened, yielding a sprinkle here and there, as we reached Greenstone Lake at the bottom of the Conness Glacier. We agreed that we wanted to get as far back into the 20 Lakes Basin as we could before the real rain arrived. We knew we had to set camp, stay dry, and cook the bratwursts spoiling in our packs. We set a good pace, using ski poles as guides. We climbed ridge after ridge, found lake after lake. Green lakes connected by glacial seepage. The country was subalpine. Tundra-like. Weathered stones stacked on grassy knolls. A few warped pines. Realizing a general lack of shelter, we hurried to the rim of a nameless lake. We settled on a grassy shelf about 20 feet above the water. There was a partial windbreak of pines and a flat spot for the tent. There were two flat-topped stones for cooking. In every direction, the mountains soared with snow-feathered wings. It was a spectacular campsite.
When I unrolled the tent, my first thought was that it used some kind of new, pop-up technology because there were no poles. It took several seconds before I realized that it was not a tent I was looking at, but a rainfly. There had been no tent in the box. No poles. Just a rainfly, a handful of stakes, and what amounted to a tarp.
A good risk manager sees the risk inherent in every action. Crossing the street. Writing a story. Starting a business. At the end of the day, it is risk that defines us more than reward. It is our time in rags we remember more than our riches. It’s the adversity we face. The willingness to face it. The courage of our choices.
Or the stupidity of our choices. The arrogance of our choices.
At 11,000 feet, encamped in the wind-polished cirques of the High Sierra, my father, brother and I had a conversation about risk. Ceding control to his two adult sons, my father declared himself neutral. My brother and I were left on opposing sides of the choice we had to make. It was clear we had no tent. We did have rope, a rainfly, and a tarp. I argued that we could build a lean-to in the trees beside us, that we’d built similar structures before and had more than once waited out storms in such structures. My brother countered that we’d never done it so high, so exposed, with weather on the way. He reminded me what everyone in the mountains knows – if you get wet, you die.
Why was I so hellbent on staying? Was it escapism? Thrill-seeking? Ego? Even now, I can’t say for sure, other than I’ve always had a transgressive personality. I am that fool who not only touches the fire, but burns down the mountain.
We compromised. My brother agreed to wait another hour to see what the weather would do. We could have exploited two hours of alpenglow if necessary. Around 6 p.m., though, the sprinkling clouds lifted. The sun made luminous blue fabric of the sky, painted the remaining clouds a comfortable pink. I declared victory, tacitly, by confirming that we were staying. Of course I knew that weather that high is unpredictable. I knew that the most dangerous thing in the mountains is a false sense of security. But like the bankers we had denounced only hours before, I proceeded to wrap others in my own risk.
The storm came shortly after dinner. There were isolated rain drops. We watched lightning flicker on the distant ridges. The clouds were roiling black, incandescent with each flash. Thunder rumbled on the open slopes. Then a loud crack. Closer. Much closer. I looked at my brother, and I thought I saw him shaking his head.
The sides of our lean-to were exposed, but it would take intense winds to drive rain into the center, where our three sleeping bags lay, or to collapse the entire structure. As if responding to this challenge, the wind picked up considerably. It started out dry, cold and manic, then attacked with stinging rain. When lightning struck the hillside above us, we were deafened by instantaneous thunder. No longer a clap. More like a piercing rifle shot. Later, we would swear we’d felt a ground current, that the air had been vibrating with electricity, almost ethereal. But that would be an embellishment of hindsight. In those moments on the ground we were pinned helplessly, pressed to the storm’s beating heart. More lightning fell upon us. Each strike revealed creation for a blinding second. Then darkness. Rain pelting us from the sides. Whipping and pounding our pathetic lean-to until water was coursing on the ground between us. We curled up as tight as we could. I lay on my hip. The thunder fluid. The deafness fluid. I saw forks of lightning licking the hill above me. I saw the faces of my wife and son.
“How does it feel to be proven right by Mother Nature?” I asked my brother.
“Let’s just get through this storm,” he said. “We have no choice but to ride it out.”
“If we survive this, I’ll let you punch me in the face.”
He didn’t punch me in the face. We decided the probability of three dots attracting lightning on an immense slope of wet rocks and stunted trees was low. It was possible for a ground current to travel along and shock our soaking wet tarp. What was more probable, however, was that the three of us would die from hypothermia around 3 a.m. after giving up a futile search for dry wood.
When the downpour subsided, we broke camp and began racing the silent flashes of lightning we could see in the southernmost corner of the horizon. Because we’d had enough foresight to cover our packs, we did have dry clothes. And we had headlamps. But this time, I let my brother take the lead. By midnight, we were footing it through the darkness along Greenstone Lake. What moonlight had broken through the cloud-cover now glowed on the high snows of Conness and North peaks. It glanced off the lakes and made ragged ghosts of the trees. At Saddlebag Lake, we faced a mile of barren talus. We guessed half an hour before the next storm. We weighed the possibility of getting stuck in the open. A few quick breaths, some arm stretches, and we were charging across the talus like three penitents on the slopes of Purgatory.
I checked my watch when we reached the truck. It had taken more than two hours of straight hiking in the daytime to reach our campsite. It had taken just over an hour to return in the middle of the night. Our bodies whimpering.
Pondering our journey, it is clear now that I gained several rewards for my risk. I got to spend quality time with my brother and father, forever bonded in terror, I got to be humiliated by the awesome forces of nature, and I got a keener sense of life from surviving an avoidable disaster.
Was the risk worth the rewards? Absolutely not.