The Literature of Derivative Finance
The financial world is typically seen as a miasma of numbers, which help to make it abstract and opaque. This essay argues that the forms and techniques of the financial world have a strong literary and linguistic dimension. This dimension can be seen in the form of the derivative, whose workings show how traders, central bankers, and analysts rely centrally on the written, spoken, and narrated word and its performative powers.
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In this essay, I will highlight the ways in which the current world of financial markets, mechanisms, and risk-taking is saturated with linguistic and literary forms. These include the promissory language of derivatives, the public pronouncements of central bankers, and the internal narratives of financial analysts. Finance today has a deep literary infrastructure which needs to be recognized and demystified. When we think about finance, our main association is with an ocean of numbers: stock prices, interest rates, currency exchange values, profit-earnings ratios, mortgage costs, credit ratings, and many other elements in the financial world are numerically expressed. We are also led to believe that financial managers and entrepreneurs are mathematics whizzes and their work is inscrutable to the rest of because it is too numerically complex for us. Yet, finance itself is deeply saturated with narrative and linguistic forms, to which numbers are largely subordinate. This is not to suggest that numbers have no narrative dimension or that they are abstract where language is concrete. Stories and numbers support one another but the narrative integument which gives numbers their persuasive force has only recently been taken seriously. What are the forms and functions of the literature of global finance?
I need initially to indicate some distinctions. I am concerned here with the most distinctive feature of the contemporary world economy, namely the central role of instruments for profitable financial risk-taking (i.e., risks involving money, not simply risks involved in production or enterprise in general). Of these, the most important is the instrument known as the derivative. Thus, though I am aware of the importance of quasi-linguistic features in previous analyses of finance,1 of value,2 of usury,3 and even of exchange at large,4 my focus on the derivative form is narrower, and thus more specific.
Before going on to some close readings, let me offer a few general comments on the ethos of global finance. United States–based banks, hedge funds, and private investors, along with a handful of players from Britain, Germany, and Switzerland, are the main drivers of global financial markets. The effort to regulate them comes from central banks throughout the world (including the Reserve Bank of India). Both sides produce a significant contribution to the literature of finance. The third great force is the media, whose coverage of finance is a big part of their intensive 24/7 coverage of business. In India, this media interest in business is reflected in TV channels devoted to business (such as CNBC), newspaper sections, and magazines, as well as blogs, tweets, and other social media platforms also following the doings of corporate financiers and leaders as if they were film stars. In regard to Indian newspapers which cover finance regularly, we have the Financial Express, Business Standard, Mint, The Economic Times, and Business Standard, along with sections, columns etc. in many other dailies. On television, we have CNBC, Business Television India (BTVI), NDTV Profit, and ET Now covering business and finance on an hourly and daily basis. In the space of magazines devoted to finance in India, we have Outlook Money, Money Today, Moneylife, Forbes India, and Business Today, to name the biggest ones. All of this media attention is not more than a few decades old, in regard to the coverage of global finance. The models for all this media coverage are doubtlessly American, but the topics and headlines are geared to Indian decision makers, businessmen, and aspiring members of India's upper middle classes who want to [End Page 49] manage or multiply their wealth. Nor is this media coverage confined to English speakers and readers. The arrival of magazines like Dhanam (in Malayalam), Money Mantra (in Hindi), Smart Investment (in Gujarati), and Good Returns (in Tamil) shows that non-English speakers in India are also being schooled in how to become modern financial subjects at a rapid pace. This Indian picture can also be seen to varying degrees in other postcolonial countries, especially those which are closely tied to global financial markets.
The main point is that this explosion of media interest in finance is not primarily about news or information. It is about pedagogy, about producing new financial subjects on a mass basis by inducting them into the language of investment and risk, wealth and profit, options and futures, interest rates and stock prices, mortgages and consumer debt. The financial media is a vast educational machine, which functions to produce the financial-citizen, who is open to borrowing, savings, investment, insurance, and more. In this essay, partly because I am in the early stages of research on this topic, I will not focus on the literature and language of the financial media in India. But financial media does shape the ecology in which banks, financial experts, and traders live and breathe and where their world meets a bigger public audience.
I will now present you with three analyses which illuminate key dimensions of the global financial economy. The first case is laid out in some detail, since it comes from my own work. The other two are sketched somewhat more briefly.
Case 1. The Derivative Promise
The first case is from my own book called Banking on Words: The Failure of Language in the Age of Derivative Finance.5
Our current era of financialization is without precedent in the speed and scope of the innovations that have characterized it. Financialization may be broadly defined as the process which permits money to be used to make more money through the use of instruments which exploit the role of money in credit, speculation and investment. Its deep historical roots lie in the epoch of the expansion of maritime trade and the growth of the idea of insurance against hazard for those merchants who shipped their trade goods across large oceanic distances during this period. Though this early period was still preoccupied by the divine and natural hazards that beset maritime commerce, the emergence of actuarial thinking in this time was the first effort to bring secular control [End Page 50] to the likelihood of disaster at sea, and insurers began to offer means of protection to merchants who feared the loss of their goods at sea. The reasoning behind this early actuarial history was a mixture of theological and statistical perceptions of risk, and it constitutes the first effort to distinguish statistically calculable risk from divine and natural uncertainty, a distinction that is the very foundation of modern finance.
The next big shift which is critical to the current power of finance is to be found in the commodity markets, notably in Chicago, in which traders first began to traffic in what became "futures," first of all in agrarian commodities (such as wheat and pork bellies) and gradually expanded to "futures" trades in all commodities with any significant market with unpredictable fluctuations in prices. Terms such as "put" and "call," "option" and "hedge" can be dated to these futures markets of the mid-nineteenth century, which remain important today, though to a smaller degree than in the period of their birth. In these futures markets, there was the first move towards separating the market in future prices from the market in current prices for commodities. These commodity futures are the earliest form of financial "assets" which are now distinguishable from the actual commodities whose prices underlay them. Today's derivatives (this term referring to the fact that future commodities are derivable from current commodities) are an extraordinary extension of these early futures contracts.
The link between the early history of insurance and the early history of futures market is that any risk of a positive change in prices (what we today call upside risks), about which a trader has doubts, can be offset, or in effect can be insured again, by taking a "hedge" position which protects traders who are convinced of a downside risk for the particular commodity price in a specific time horizon. The hedge is essentially a dynamic form of insurance.
What the derivative is and what it does are closely tied. The derivative is an asset whose value is based on that of another asset, which could itself be a derivative. In a chain of links that contemporary finance has made indefinitely long, the derivative is above all a linguistic phenomenon, since it is primarily a referent to something more tangible than itself: it is a proposition or a belief about another object which might itself be similarly derived from yet another similar object. Since the references and associations that compose a derivative chain have no status other than the credibility of their reference to something more tangible than themselves, the derivative's claim to value is essentially linguistic. Furthermore, its force is primarily performative, and is primarily tied up with context, convention, and felicity. More specifically still, while the derivative is thus a linguistic artifact, it is even more specific in that it is an invitation to a performative insofar as a derivative takes full force when it is traded, that is, when two traders arrive at a written contract to exchange (buy and sell) a specific bundle of derivatives. The promise is for one of them to pay money to the other depending on who proves to be right about the future price (after a particular and specified temporal term) of that specific derivative. In this sense, of course, all contracts have a promissory element. But the derivative form is the sole contractual form that is based on the unknown future value of an asset traded between two persons. Other contracts have known future values, known [End Page 51] terms and known current values (such as with loans, rents, and other pecuniary contracts). Thus, when an entire market driven by derivatives comes to the edge of collapse, there must be a deep underlying flaw in the linguistic world that derivatives presuppose.
The link between derivatives and language turns on the question of promises, which I view, following J. L. Austin, as one of the class of performatives, linguistic utterances that, if produced in the right conditions, create the conditions of their own truth.6 Elie Ayache, a derivatives trader and a French social thinker, has established the importance of seeing derivatives as written contracts.7 I am indebted to him for establishing that derivatives, in the end, break free of the prison house of probability, and that specific derivative trades, in real-time conditions, are best seen as written contracts. These contracts continuously create their own conditions of effectivity in a volatile market of future prices in which probability is at best a partial guide to what the two contracting parties agree upon when a derivative is sold and bought.
Ayache underlines the fact that the derivative trade is a time-bound contract about a definite future date on which an indefinite (or unpredictable) price might be set by the (future) market for a current derivative asset. He does not ponder the contractual side of the derivatives contract except to note that it is written, and therefore needs to be grasped as a written text about the unknown future, which commits the two trading parties to a specific transfer of money at a future date.
Though today's derivative contracts, like all modern contracts, are ideally in written form, their underlying force comes from the fact that they are composed of a mutual pair of promises, a promise to pay in one direction or another, at the expiry of a fixed period of time, and depending on the price of the derivative at that future time. This mutually binding promise is initially oral, and only incidentally committed to writing as confirmation and for the purposes of tracking and record keeping. A derivative trade is complete when the two traders, often on the phone, say "It's done."8 This is a classic Austinian performative moment.
In Austinian terms, the conditions of felicity for this pair of promises to take its force include the mutual knowledge of the traders, the capacity of their larger institutions to fulfill the downside risk of large payments, and the general social network of managers, regulators, small shareholders, and large investors which lends an appropriate audience (even if virtual) for the transaction.
The systemic weakness of the larger financial system within which derivatives circulate is that it allows for the repeated commoditization of prior promises by new promises, thus diluting and disseminating the force of the promise across many players (traders) who bear only tiny portions of the burden of the larger interlinked system of promises that comprises the overall value of any particular derivatives market. This opens the systemic possibility of failure, breakdown, and collapse even when the bulk of individual trades meet their local conditions of felicity. This systemic dissemination of promises is connected to the idea of a performative chain. Put another way, when the contractual nature of the promise is subject to infinite further monetization, risks can be taken on prior risks and money can be made of speculative instruments that involve growing distances between [End Page 52] derivatives and their underlying assets, which are frequently themselves derivative. This recursive chain of derivatives is the essence of the world of the subprime housing mortgage. Derrida did notice this repetitive and recursive potential in the Austinian performative, but he did not notice its capacity for multiplying tradable value.
It is through the lens of housing mortgages that we can examine most closely the sense in which the failure of the housing market that led up to the collapse of 2007–8 can be seen, at its heart, as a linguistic failure. This argument interprets the indefinite dispersal and dissemination of promises, as well as the monetization of the entire series of promises, as opening the door to a massive disconnect between the ideal and the reality of the system of derivative trading.
Put simply, every derivative trade involves a winner and a loser, the one who pays at the end of the stipulated term, at the new price, and the one who receives a payment. In principle, this should create a perfect balance between winners and losers with no gains at the end of any given period, across the entire system. Why does it not end up this way?
There are several reasons for this failure at a systemic level, in spite of a largely legal and rigorous system of reciprocal promises at the level of the individual contract. The housing market offers a clear example of the problem. As long as housing values continued to rise (and seemed likely to rise indefinitely), the growth of the market in housing derivatives, composed of a huge chain of derivative trades, based on bundling individual mortgages, seemed to be built on a reasonably positive relationship between the value of homes and the value of housing derivatives, which could sustain an exponentially growing derivative market. In other words, the ratio of housing values to the value of derivatives based on mortgages could be seen as systemic protection against collective risk. But the housing market did collapse, as it had to someday, and the abilities of various sellers of housing derivatives to find buyers disappeared, creating a freezing of liquidity and a grinding halt to the promise machine.
Each promise made in the great chain of promises represented by the trade in housing derivatives was reasonably valid. But the capacity of the overall system to bear the load of the chain of promises was stressed beyond easy retrieval. This disjuncture has partly to do with the volume of promises creating immense crosscutting promissory chains that were bound to weaken as they became more extended. Worse, every link in the promissory chain was built on greater risk, as distance from the underlying asset was increased. The greater the distance between the two, the larger the gap between the real value of the underlying stock of homes and the overall derivative system based on housing. As risks grew, the housing market became like a toxic version of the Kula ring in which valuables were traded across a circle of islands in the Pacific to [End Page 53] generate both wealth and status by circulating various categories of valuable objects.9 In the mortgage market in recent years in the United States, traders sought to move their toxic derivatives rapidly to the next buyer, as the inevitable drop in housing values became imminent. At the end of this chain, when the disaster hit, was the insurance giant, AIG, which in effect was caught holding a massive number of toxic derivatives when the music stopped in 2007.
The conventional wisdom usually lays the blame for the collapse on irresponsible lenders, greedy traders, co-opted rating agencies, and weak regulations. Each of these has some relevance. But at the heart of the collapse of the housing derivatives market and thus of the financial markets as a whole, was the form of the derivative, which involves piling risk on risk, thus making risk an independent source of profit, with little basis in the realities of production, price, and commodity flows. In a world of derivative assets, money breeds more money, if risks can be bought and sold through securitization, debts can also be bundled, repackaged, and sold, time and again. This dynamic liberates money almost entirely from Karl Marx's famous formula—M-C-M—and allows money to grow, as if magically, on its own, through risk-based credit trading. I now supplement this detailed case study with two shorter accounts from the work of other scholars of finance.
Case 2. Financial Analysts
My second case comes from an ethnographic study by Stefan Leins of the building of narratives about the economy by a group of specialists called financial analysts within a major global Swiss investment bank.10
Leins emphasizes the role of narratives about the economy as a whole, about particular sectors in it, and about particular corporations, that are produced by various specialists in investment banks. These specialists combine a certain literacy in economics and finance with a shrewd sense of the unknowability of the future and a strong sense of investor psychology. They work with other groups within large investment banks, such as quantitative specialists ("quants"), traders, managers, and salesmen, to produce a narrative line which knits together all these activities. Leins brings together the work of Jens Beckert, on the central role of the unknown future in all contemporary economic practices, and my own work on the relation between promise, contract, and the derivative form, to offer his own analysis of the place of financial narratives in making the future seem more legible and manageable.11 He notes that companies that are already known to produce profits rarely have a low stock price, and hence are not ideal investments for someone entering the market at a late stage. Rather, the idea is to find companies whose potential value has not yet been discovered, whose real value lies in the future. To make such identification not appear to be an arbitrary gamble, financial analysts have to create a credible picture of the unknown future of companies and the sectors of the economy to which they belong, which also has the look of special and privileged forecasting. A concrete example of such a financial narrative is to be found in Leins's discussion of the genre called "The Company Report": [End Page 54]
Swiss Bank's financial analysts communicate their market forecasts in various ways, ranging from oral advice or short e-mails to more institutionalized forms. Of the more institutionalized forms, the company report is the most established. . . . Analysts are expected to write a company report every time a company they cover publishes its numbers or announces a change in strategy. Company reports contain the numbers reported, a variety of other market data, and investment advice that gives investors an idea of how the company's stock price might develop in the future. The content of the company report illustrates how financial analysts interpret and communicate their visions about a company, the overall economy, and the future development of financial markets. Above all, however, it illustrates how financial analysts construct and communicate investment narratives that look coherent and are built to persuade investors. In company reports, analysts use not only text, but also illustrations, charts, and tables. In so doing, they produce reports that look both appealing and sophisticated.12
Thus, what we can derive from Leins's study of the role of financial narratives in mediating the link between investors and big banks is that such narrativity operates through a series of conventions for making predictions and recommendations about the future of specific stocks of specific companies. These conventions involve particular combinations of graphic and verbal mains, of particular ways of linking charts and numbers to stories and events, and particular ways of communicating the prudence, expertise and specialized insight of the bank to its potential investors. In this process, whether or not investors become rich, they become pedagogical subjects of industry narratives of uncertainty, risk, profit, and prediction. They are drawn into the world of high-level investment and seduced by their membership in what appears to be a private club of experts and a privately held fund of narratives about the economic future.
Case 3. Central Bankers' Pronouncements
I turn now to my third case, which is based on the work of the anthropologist Douglas Holmes who has been working for almost two decades on the public statements and speeches of central bankers in many different parts of the advanced industrial world.13
Holmes shows us that a great deal of what central bankers do is to treat the economy as a field of communicative action, in which their public pronouncements have the capacity to produce stability, confidence, and calmness among citizens in constant danger of succumbing to panic, volatility, and excess. In building these pronouncements, which are typically short and couched in simple lay terms, central bankers draw upon a vast range of qualitative and quantitative information to which they have privileged access. But their role is not simply to translate number into prose, but to mediate the built-in volatility and opacity of financial markets, players, and institutions to create the impression of transparency and legibility. In Holmes's view, central banks have created a "performative apparatus" to recruit the public to fulfill the banks' policy aims. These aims are to stabilize a specific monetary regime to smooth out the rocky ride that all nations [End Page 55] normally have in the global financial markets. These central bank pronouncements constitute a particular sort of monetary narrative. Here is how one reviewer describes what Holmes shows about the making of this sort of narrative in the countries whose central banks he studied:
Bank leaders thus devised new forecasting models; created networks of contacts who could be consulted for anecdotal insights on the economy; and embraced transparent economic planning as a method to instill public confidence in the economy. These developments combined to form the "performative apparatus" that Holmes describes: an interface through which central bankers engage the public-at-large, both culling and delivering information, in an ongoing, real-time experiment of macroeconomic governance. In this configuration, the continually updated monetary policy story merges the quantitative and the linguistic to render the economy as something susceptible to policy interventions while also modeling a dynamic relationship with the public.14
Exactly how this monetary narrative is crafted is scrupulously reported by Holmes in an essay on the workings of the Reserve Bank of New Zealand, which used multiple methods to capture public economic sentiment, shape public understandings, and create a performative web of narrative which made their own policy preferences seem like outcomes rather than drivers of the actions of economic actors in New Zealand society.15 One of these methods was a remarkable form of top-down ethnography, in which the Governor of the RBNZ made monthly "field visits" across New Zealand where he communicated bank policies and also actively solicited stories—essentially anecdotes from a large variety of economic actors such as producers of wool and oil, distributors, real estate brokers, bank staff, and many others, providing a dialogic occasion for the financial numbers to be turned into the prose of finance and the narrative was made to fit local expectations and global competitive pressures and shifts. These encounters helped the RBNZ and ordinary New Zealanders to translate abstract economic forces into the web of their lived experience. And here is how these dialogic experiences fed into the narrative machinery of the bank:
The RBNZ listed over fifty companies and organizations it had consulted during a recent quarterly "projection round" while noting that it had established contact with "other companies and organizations for feedback on business conditions and particular issues relevant to our policy deliberations." These interlocutors were simultaneously the source of bank intelligence and the primary audience for bank communication.
The analytical scenarios that emerge from within and outside the bank undergo a two-fold interpretive process. First, they are recast as essentially an argument or arguments for a specific policy stance. A small group of senior officials, including members of the MPC and the smaller Official Cash Rate Decision Group (ODG), interpret econometric projections and other data and information, refining them for the purposes of advising the Governor on the setting of the bank's policy rate, the Official Cash Rate (OCR). Second, they are re-articulated as a public statement composed for the purposes of shaping and anchoring [End Page 56] expectations on the evolution of prices. An even smaller group of advisors assisted Governor Bollard in drafting these public communications. These individuals craft and edit these statements, and generally oversee the rhetorical expertise of a central bank.
The "Policy Assessment," issued every six weeks by the RBNZ in support of its decision on interest rates represents a key example of these communications.16
In other words, Holmes's work on the public pronouncements of central bankers also shows that the financial markets crucially depend on the narration of possible (and plausible) economic futures through the production of authoritative narratives which induct the general public into a performative space in which they are both active and complicit.
I have taken you through three recent perspectives on the relationship between words, speech acts, and narrative forms in today's financial world: my own work on derivatives, promises, and performativity; Stefan Leins's study of financial analysts in a Swiss investment bank; and Douglas Holmes's work on the public communications strategy of major central banks in European and Commonwealth economies. My aim is to show not only that finance produces its own language and literature but that this literature is a vital part of finance, both for insiders and for the public. In this sense, the perception of finance as largely numerical is wrong. This misperception is itself an ideological product of the literature of finance and is part of the way in which compliant financial subjects are being produced worldwide, also in postcolonial spaces. We need a critique of this literature as a first step towards demystifying finance and resisting its colonization of everyday life. To develop such a critique, we will need to deepen our sense of the literary infrastructure which allows derivatives to generate a pyramid of promises, a chain of performatives, in which sheer rhetoricity is supplemented by a new sort of supplementarity, and through which the economy of words acquires its own principles of growth and acceleration. It is also worth noticing that this emergent derivative logic also produces derivative and fragmented "dividuals," which also contain the potential for progressive political associations and assemblages, now free of the empire of the individual. [End Page 57]
5. This section draws heavily on my 2016 book, Banking on Words.
16. Holmes, 27–28.