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Patrick Toomey: From Wall Street to Capitol Hill

By Robert Hunter

The seats on Capitol Hill are mostly filled by lawyers and career politicians, with the financial world—to say nothing of the derivatives community—getting short shrift.

But now the derivatives industry can claim representation by one of its own. Last November, Rep. Patrick Toomey (R-Pa.), a former swaps dealer, was elected to represent his Lehigh Valley district.

Toomey’s road from Wall Street to Washington was circuitous. After getting a political science degree from Harvard, Toomey landed a job in Chemical Bank’s capital markets group in 1984. In order to build its eurobond issuance business with American corporations, Chemical began offering interest rate and currency swaps, and Toomey was soon helping out with the bank’s earliest swaps transactions.

Two years later, he and six associates were lured to Morgan Grenfell, the British merchant bank, to start what Toomey calls a “serious derivatives operation” designed to drive the firm’s slow-growing dollar-denominated eurobond business. “We traded a portfolio 24 hours a day, and it became quite sophisticated, as all the big financial houses did during the 1980s,” he says. “We were dealing in various currencies, all kinds of interest rate and currency-related derivatives—options, swaps, forwards and so on.”

In 1991, Toomey took a leave of absence to work on a consulting project. A few months later, after Deutsche Bank acquired Morgan Grenfell, Toomey decided not to return to the firm. “Deutsche Bank was a very different kind of institution,” he recalls. “Morgan Grenfell was a much smaller firm, much less formal, with a less bureaucratic structure. Our independent entrepreneurial subsidiary, under the ownership of Deutsche Bank, was going to be folded into Deutsche Bank’s treasury department, and I was not at all interested in that arrangement. I liked flexibility and entrepreneurship.”

His next move was entrepreneurial indeed. In 1991, Toomey opened Rookies’ Restaurant in Allentown, Pa., with his brothers, and spent the next few years building the family business. Then came the 1994 elections, which rekindled his passion for politics. “1994 was a watershed year,” he says. “There was a realigning election, and when I saw the Republican party take control of both houses of Congress and state legislatures and governorships across the country, I was very enthusiastic. As a conservative, I felt that this was the first opportunity in my lifetime to participate in the process within the context of a majority and actually make something happen.”

Toomey began following the local political scene closely. After the 1996 election, he believed the time was ripe for a House run. Last November, he was one of the few bright spots in a lackluster Republican showing.

Toomey’s first order of business as a freshman congressman: getting some good committee work. His Wall Street credentials—as well as the Republican majority—helped him score a seat on the House Banking Committee, where he sits on the Capital Markets, Securities and Government Sponsored Enterprises subcommittee as well as the Domestic and International Monetary Policy subcommittee. Toomey has already helped draft House Resolution 10, a proposal to roll back some of the Glass-Steagall legislation of the 1930s. Not surprisingly, Toomey is virulently opposed to unnecessary regulation. “The trend in deregulation, beginning in the early 1980s, is one of the biggest reasons for the sustained economic expansion,” he says. “I would like to see us continue to deregulate on many fronts, including the financial services industry.”

And what of the much-ballyhooed hedge fund regulation talk emanating from Washington lately? “It’s not clear to me that the problem with Long-Term Capital Management requires new regulation,” he says. “I think we need to continue to work on understanding what really happened there and what the magnitude of the threat to the infrastructure of our financial services industry was. Frankly, I think that the outcome was appropriate. The equity investors lost everything—and under the circumstances that had to happen—but the bailout essentially worked. I would be very leery about, and I will resist, any effort to impose inappropriate regulations as a knee-jerk reaction to what was a big problem but was essentially solved.”

Such passionate discourse is music to the ears of derivatives players around the country.

Gregg Whittaker Bows Out

Many Wall Street high rollers come to New York with a simple plan: stay for five or 10 years, make a bundle of money and then return to small-town life. Decades later, many still find themselves kicking around the Big Apple, unable to say goodbye to its seductive—and for some, bacchanalian—lifestyle.

For Gregg Whittaker, the former global head of credit derivatives at Chase Securities, the decision to pack up and leave New York was simple. “My wife and I had been talking about a five-year plan for five years,” he says. “Most of our friends and family knew about it, but didn’t really believe it.” Whittaker announced on April 6 that he was resigning from Chase effective immediately to pursue a career in academia somewhere in the Midwest.

Whittaker’s team at Chase was shocked, and for good reason—the Colorado native had led a charmed life in the derivatives world from the beginning. He wrote his dissertation at the University of Wisconsin on valuing swaps in an options-pricing framework, producing what is believed to be the first published treatise on swaptions. After stints running the fixed-income derivatives groups at Northern Trust and D.E. Shaw, Whittaker moved to Warburg in 1992 to take on equity derivatives. Two years later, he moved to Chemical Bank to start its credit derivatives business. When the bank merged with Chase, Whittaker became Chase’s global head of credit derivatives. Perhaps his biggest legacy is Chase’s wildly successful Secured Loan Trust Note product, a second-generation collateralized loan obligation.

“I’m incredibly proud of that product,” he says, “and of the entire Chase group. It’s the best team of people on the Street. I just felt it was time to move on.”

His first order of business: decompressing in the local multiplex, where he caught a matinee showing of “Ed TV.” “I spoke to a colleague of mine from Chase that day,” he beams. “I said, ‘It’s such an incredible day today—the weather’s beautiful.’ He said, ‘You mean there’s weather during weekdays?’ I’ve already begun to enjoy some of the things I’ve missed the last 12 years.”

Joseph Jett’s Phantom Bets

By Peter Vinella

Joseph Jett should be in jail. If not for securities fraud, then at least for writing this book. In a word, it is an embarrassment.

When I was first approached about reviewing Black and White on Wall Street (William Morrow, $25), my assignment was to determine how, over several years, he apparently lost $350 million without anybody knowing about it. This seemed simple enough. I had heard him describe his trades last year at a Derivatives Strategy conference and, at that time, it appeared that he was simply long the market when it tanked in 1994. No phantom trades, just normal off-balance-sheet contingent claims that went against him. I thought I would only have to skim through the book to the section that described his trades, then analyze his positions and confirm my first impressions.

I was wrong.

The book turned out to be a rambling statement of trading ignorance, blind racism and unfailing ego. It is both a 367-page testimony to one man’s attempt to exploit his 15 minutes of fame and a shameless attempt to explain away a crime through bombastic self-aggrandizement. Those with even the slightest trading background will find themselves torn between laughing at the sheer stupidity of the book and becoming angry that anything this ridiculous should get any attention whatsoever. Simply put, Black and White on Wall Street is the Beyond the Valley of the Dolls of business literature. One only hopes it doesn’t get the same cult following.

It’s also clear to me that Jett didn’t write the book—he merely recited it. The book is a collection of transcribed narrations. The rhythm is spoken rather than written. Thoughts and ideas begin focused and then trail off into nothingness. Chapters skip back and forth in time with few clues and entire phrases and passages often repeated.

But style and literary quality aside, I find Black and White on Wall Street offensive. It insults the reader’s intelligence by draping a rather small and petty act, notable only for its size, in the guise of cheap sex, racism and sensationalism. Jett credits only himself for his successes and blames his race and the racism of others for his failures. His tone is so arrogant and so conceited that it is truly difficult to read the book.

My biggest objection to the book, however, is more personal. He incorrectly and obscenely describes a world I know all too well. I went to the same restaurants, lived in the same neighborhoods and went to the same clubs. (I was in Nell’s nearly every night for three years and, although I was looking pretty hard, never saw any bare-breasted women or sex on the sofas.) I also put on some of the same trades as Jett, yet his world is alien and repugnant to me.

Trading Errors

As for Jett the trader, he is laughable. Throughout the book, he pontificates on his economic prowess, his quantitative skills, his knowledge of the ins-and-outs of the business, and his street savvy. Yet for all the effort, he comes off as a complete buffoon.

The book would be unbelievably boring if it weren’t for the preposterous ideas and wild inaccuracies that litter nearly every page. For example, he goes to great lengths to describe why he believed the market would rally when the Treasury Department went from quarterly to semi-annual auctions. His logic: the shortage of securities would create upward price pressure while the infinite supply of futures would cheapen their price. At another point, he explains that his boss, Mel Mullin, disliked the high risks associated with arbitrage. But after reading the description of one of his “arbs”—a 10-year/two-year curve trade—I understood Mullin’s hesitancy. In Jett’s world, futures must be borrowed to cover short futures positions, and using balance-sheet capital is the same as spending money. For Jett’s sake, I hope this was just a case of his laziness in proofreading the book. He can’t really be that ignorant about the market.

Jett didn’t lose $350 million in the market—he merely booked $350 million in trading profits he never actually made.

Contrary to my initial belief, I learned that Jett didn’t lose $350 million in the market—he merely booked $350 million in trading profits he never actually made. How was Jett allowed to place these phantom trades, generate profits on them and have them go undetected for so long?

From 1992 through 1994, the Treasury bond went from nearly 8 percent to 6 percent and back to 8 percent. Since Treasury strips rally in bull markets and tank in bear markets, one could have assumed that Jett was long the whole roller coaster—a hero on the way up and a goat on way the down. What becomes clear in the book, however, is that Jett wasn’t really trading at all. His alleged profits were nothing more than the result of weak systems and accounting procedures, just as General Electric, Kidder’s parent company, claimed.

Jett attributes his trading profit to reconstitution trades, although no such kind of trade actually exists. He argues, correctly, that in order to reconstitute a series of strips, they must be delivered to the Fed, which in turn returns a bond. Jett even mentions that there is no profit-and-loss associated with this reconstitution. To get the strips off his internal Kidder systems and to get the bond in, however, he had to enter buy and sell tickets even though no actual trades took place. This was simply a way to delete the strip positions and entry the bond. There was no actual settlement.

In Jett’s opinion, however, the delivery of the strips to the Fed and the subsequent receipt of the bond constitute actual trades with the Fed as the counterparty. Jett further compounds this farce by creating a new term—”time value.” He says he discovered that while holding a bond for a three-month forward sale, he could earn this unexpected time value on top of the capital gains. Most readers will recognize this as simply accrued interest. In normal practice, the price for all forward-settling bond trades must be adjusted by the accrued interest, since the price of the bond is the sum of the net present value of the remaining cash flows.

The important point here is that Jett didn’t have to concern himself with any of this, since no actual counterparty existed. In fact, on Page 288 of the book, Jett describes a discussion with Mullin in which Mullin explicitly points out this fact. Jett’s response is remarkable. He argues that a forward reconstitution created a short position in the strips whose negative accretion (carry) would offset the accrued interest of the bond. But what short position is he talking about?

Kidder’s deficient front-office system erroneously showed a forward risk position. But since there was no actual forward trade and therefore no associated market risk, he could simply buy strips at the market price for same-day settlement, deliver them to the Fed for reconstitution, receive the bond and sell the bond that day in the market. Hence, there was no negative accretion because there was no need to hedge. Whatever trading P&L occurred during the reconstitution could be hedged with futures and would, in any case, be dominated by the phantom positive carry of the long bond position—the bigger the position, the bigger the phantom accrued interest.

Joe Jett didn’t lose any money. He never made it in the first place. He was paid a substantial bonus based on phantom profits generated strictly from operational and technological deficiencies. It is quite clear from the book that Jett knew what he was doing. The big question is, How many other people knew?

Clearly, anybody who wanted to know could have easily found out with a little due diligence. It is marginally conceivable that by looking only at the back-office and trading system reports, some managers could have seen reasonable activity and positive P&L, and guessed that nothing was irregular. But given Jett’s inexperience, the market roller coaster that everybody was riding at the time and the size of profits, any competent manager should have known that somebody was cooking the books. I guess there was just too little incentive, given the fact that other bonuses were heavily dependent on Jett’s phantom profits as well.

Jett was not a “big swinging dick,” as he calls himself. He merely took advantage of poor systems and even poorer oversight. Considering the effects of his actions on Kidder, it is sad that Jett is still fighting to defend himself when he basically admits his own guilt in print. Maybe he believed that if he wrote his book badly enough, he’d be able to make his money back interpreting it on his lecture tour before anybody figured things out.

Peter Vinella is president of PVA International Inc. He can be reached at puv@vinella.com.

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