This round robin is amusing enough for me to include it here - Zhou Xiaochuan is the Governor of the People's Bank of China. Imagine the following phone call.
(Note: I do not vouch for the economics displayed here, but thatb does not matter since it reflects the simple-minded economics of many politicians).
Zhou: Hello. Dr. Bernanke?
Bernanke: Yes.
Zhou: I wanted to let you know about the decision that our board has taken, after consulting with the Premier and the Politburo's Standing Committee. We hope you are sitting down.
Bernanke: I get it. A little Oriental humor.
Zhou: You could say that.
Bernakne: What can I do for you?
Zhou: You can abandon your plan to purchase $600 billion of Treasury bonds.
Bernanke: The Federal Open Market Committee voted ten to 1 for this policy. I cannot change it now.
Zhou: We think it is an unwise policy. It will lower the value of the dollar. Americans will then buy fewer goods from China.
Bernanke: That is not how we see it. We think the policy is required to put Americans back to work. They will buy more goods from China and everywhere else when they are once again working.
Zhou: You will increase the supply of dollars, which will lower the dollar's price internationally. Imported goods will cost Americans more. An increased supply of dollars will mean a lower price for dollars. It's supply and demand.
Bernanke: That is the old economics. That is the logic of Adam Smith and Milton Friedman and those kooks from Vienna. We are committed to the new economics.
Zhou: Who teaches it? Where?
Bernanke: I taught it for years at Princeton.
Zhou: Where Paul Krugman also teaches?
Bernanke: Yes.
Zhou: We see it differently here. We prefer the older economics.
Bernanke: Adam Smith's economics?
Zhou: No, even older.
Bernanke: Mercantilism?
Zhou: That is what you call it. We call it the export-driven Asian miracle.
Bernanke: But mercantilist governments wanted to hoard gold. Your nation does not hoard gold. Your bank holds U.S. Treasury debt.
Zhou: That is the purpose of my call.
Bernanke: Gold?
Zhou: No. U.S. Treasury debt.
Bernanke: What about it?
Zhou: There is too much of it.
Bernanke: You sound like Ron Paul.
Zhou: Ah, yes. Congressman Paul. I understand that he is likely to be the next chairman of the Monetary Policy Subcommittee. You and he should have some interesting
discussions.
Bernanke: I prefer to talk about Treasury debt.
Zhou: We have determined that an increase of $600 billion in your purchases of Treasury debt will lower the rate of interest on the debt.
Bernanke: That is our thought, too.
Zhou: We hold almost $1 trillion in Treasury debt.
Bernanke: You ought to buy more.
Zhou: We will be losing money on our holdings if rates
fall.
Bernanke: You ought to buy more.
Zhou: The value of the dollar will fall. That will lower the value of our holdings.
Bernanke: Nevertheless, you ought to buy more.
Zhou: We have decided to own less.
Bernanke: How much less?
Zhou: $600 billion less.
Bernanke:
Zhou: Dr. Bernanke?
Bernanke:
Zhou: Are you still there?
Bernanke: I am still here.
Zhou: We have decided that every time the Federal Reserve purchases its monthly total of $75 billion, we will sell $75 billion.
Bernanke: Are you serious?
Zhou: You sound like Nancy Pelosi.
Bernanke: But that would raise interest rates on Treasury debt.
Zhou: That is our conclusion, too. But remember: we own lots of Treasury debt. We could use a better rate of return.
Bernanke: But higher rates might cause a recession in the United States.
Zhou: That is our conclusion, too.
Bernanke: But that will mean fewer imports from China.
Zhou: We think it will mean more bankrupt manufacturing facilities in the United States. Then Americans will come back to our manufacturers.
Bernanke: But this could cause unemployment in China if you are wrong.
Zhou: We are willing to risk that.
Bernanke: That is a big risk on your part.
Zhou: No bigger than the risk on your part by inflating the monetary base by 30%. That could raise prices in the United States.
Bernanke: We don't think so.
Zhou: Why not?
Bernanke: Because our bankers are so frightened of recession in 2011 that they are not lending. They just turn the money over to the FED.
Zhou: Then you do not expect inflation?
Bernanke: Only a little. Maybe 2% to 3%.
Zhou: You sound like Milton Friedman.
Bernanke: Around here, we say, "Better 2% inflation than 9.6% unemployment."
Zhou: We think it is better for us not to hold onto Treasury debt that cannot be paid off.
Bernanke. Don't worry. We owe it to ourselves.
Zhou: On the contrary, you owe it to us.
Bernanke: It's only a figure of speech.
Zhou: We can figure. We are going to be left holding the bag, as you say. All we have is a pile of IOUs.
Bernanke: They're as good as gold.
Zhou: Since they pay zero interest, we think gold is better.
Bernanke: It's only a figure of speech.
Zhou: We can figure. Gold is over $1,350 an ounce. The dollar has been falling. We think the older mercantilism was right. We want to own more gold.
Bernanke: You can't eat gold!
Zhou: We can't eat T-bonds, either.
Bernanke: But if you sell dollars, their price will fall.
Zhou: Why?
Bernanke: It's supply and demand.
Zhou: Gotcha!
Bernanke: You speak English very well.
Zhou: You see, I was educated in your country at UCRA.
Bernanke: Really?
Zhou: Not really. But I love those old Richard Loo World War II movies. He made a great Japanese officer.
Bernanke: But if you sell Treasury debt, that could start a fire sale. Central banks all over the world might start selling T-bonds.
Zhou: That is a possibility.
Bernanke: But that would make your holdings worth even less.
Zhou: That is true. So, if Japan starts selling, we will dump all of our holdings in one shot. We might as well get out before the rush.
Bernanke: But that could crash the dollar!
Zhou: That is a possibility.
Bernanke: You're bluffing!
Zhou: That is a possibility.
Bernanke: But this is not the way that central banks operate.
Zhou: How do they operate?
Bernanke: They inflate.
Zhou: Always?
Bernanke: Of course always. That is the only policy tool we have.
Zhou: You could deflate.
Bernanke: Are you serious?
Zhou: You really have Nancy Pelosi down pat.
Bernanke: There is no way we can deflate.
Zhou: What about your exit strategy? That is deflation.
Bernanke: In theory, yes. But we don't intend to execute it.
Zhou: That is not what you told Congress. You told Congress you have an exit strategy. Several, in fact.
Bernanke: We do have them. We just don't intend to implement them.
Zhou: Do you think you can fool Congress?
Bernanke: Are you serious? Congress doesn't know horse apples from apple butter.
Zhou: You mistake Barney Frank for Ron Paul. You will now have to deal with Ron Paul.
Berrnanke:
Zhou: Hello.
Bernanke:
Zhou: Are you still there?
Bernanke: Yes, I'm still here.
Zhou: We are not asking you to deflate. We are asking you not to inflate.
Bernanke: But we must inflate.
Zhou: Why?
Bernanke: Because we have 9.6% unemployment.
Zhou: What has that got to do with your decision to inflate?
Bernanke: We must lower interest rates.
Zhou: For Treasury bonds.
Bernanke: Yes.
Zhou: What does that have to do with unemployment?
Bernanke: When mid-term rates are lower, businesses will start new projects and hire people.
Zhou: Mid-maturity T-bond interest rates are the lowest ever since what you call the Great Depression and what we call the old normal.
Bernanke: You can never have low enough T-bond rates.
Zhou: But, as Treasury bond investors, we don't like low rates. We like high rates. We hold lots of T-bonds. If we get very low rates, we might as well own gold.
Bernanke: But you will like all that increased demand for made-in-China goods when all those unemployed Americans go back to work.
Zhou: But rates are lower than they have been in 80 years. You still have 9.6% unemployment.
Bernanke: But if the 10-year T-bond rate goes from 2.6% to 1%, American businessmen will hire millions of workers.
Zhou: Do you have evidence for this in one of those dozen Federal Reserve bank monthly bulletins? Or maybe in the "Federal Reserve Bulletin"?
Barnanke: Not really. But it's the thought that counts.
Zhou: I don't think we are getting anywhere. So, just to remind you. We will sell enough Treasury debt each month to match any net increase in the amount you buy.
Bernanke: Dollar for dollar?
Zhou: Dollar for dollar. But, I'll tell you what. Buy them from us, and we'll give you a discount for volume purchases.
Bernanke: You guys never miss a trick, do you?
Zhou: We're really not inscrutable. We just offer discounts for volume purchases.
Bernanke: I will discuss this with the FOMC.
Zhou: Do that. Shalom!
Bernanke: That's my middle name.
Zhou: You Americans have a saying for everything.
Bernanke: No. I mean it. That really is my middle name.
Zhou: If you start buying Treasury debt, you'll have an honorary middle name over here.
Bernanke: What's that?
Zhou: Paper Tiger.
Friday, 12 November 2010
Wednesday, 1 September 2010
ANALYSTS OVERSHOOT ECONOMICS
Corporate earnings and sector analysts are supposed to be good at analysing companies published accounts, but when so much depends on where the economy is going and how the economy is currently, the most important data may be outside company and economic sector returns. That leaves analysts at sea with everyone else and, in any case, there is obviously a lot of room for subjective judgement.The above graphic shows how analysts go with the flow and are either more bullish or more bearish than the underlying reality. We could conclude that analysts are often doing a boring job that only makes sense if they can find more drama in the results one way or the other. Arguably, this is what they are paid for, to shake the trees, or as broker parlance has it, cage-rattling to encourage investors to churn their portfolios.
Every day media continues to voodoo poke at the chicken bones and tea leaves to predict signs of general economic recovering health or persistent illness. Market analysts appear to have zero expertise in identifying, anticipating and responding to economics data. Most stock analysts would have a hard time dissecting employment data, consumer spending data, or understanding even how GDP and GNP are calculated. Its outside their training, world view, or above their pay grade? That opinion is echoed in the FT.
Classic statements by analysts today are along the lines of "Company X or these companies in sector X look pretty good, earnings up OK, plenty of cash or borrowing head-room... But, what if there’s a double dip, Aaaaah?" and then too the usual caveat of "I’m no macroeconomist, but... debt... deficit... trade... what if consumers... non-farm payrolls... Feederal measures... recovery policy run out of steam" i.e. simply reflecting news media talking heads running commentaries. Analysts can have some idea of 'recession-proof' or 'recovery' stocks, but not much.
It is not long since investors were being advised to remain 80% in cash. Markets are volatile as short term profit-takers and Asian day-traders continue to dominate. Hence, the Buy/Sell/Hold opinion-formers remain edgy or cautious.
In the world's bell-weather of US stocks, according to 159,919 buy/sell/hold recommendations compiled by Bloomberg, less than 29% of stock ratings covered by brokerages worldwide are “buys,” (lowest % since at least 1997). Analysts are bearish even as predict 36% higher profits for S&P 500 companies, highest since 1988. Over 54% of company stocks in US, UK, Japan and Brazil are “holds,” (highest % since 1997), while %n of “sell” ratings in the U.S. is down to 5.1%, half the % of 2003, and the total combined with “holds” = a record 71% in August.
Following brokerage analysts is rarely a guaranteed way to make gains. Collectively, the analyst community is excessively bearish, which contrasts with their more typical stance of being excessively bullish.
In macroeconomics, taking the consensus or median view is always a smoothed view. In the microeconomics of stock analysts, the consensus is always likely to be an exaggerated view. In both cases the turning points are never accurate, in large part because analysts are part of the market and can pre-empt changes in perception, but also because there is an inevitable 'camera-shake' in short term forecasts. Markets gyrate naturally by about 1.5% daily in stock markets and that means up to 3% for individual stocks. Like throwing dice or flipping coins stocks can experience several days of rises or falls without that necessarily reflecting actual micro or macro fundamental factors underlying. This does not stop media or analysts always trying to find a logic for every set of price moves - often when there is no actual logic i.e. markets are accident-prone and febrile and inconsistent - notwithstanding all the chartists with their pattern recognition software.
Why should there be so many bearish stock calls from equity analysts these days - is it because the rear-view mirror dominates when the windscreen view is relatively foggy or blank? Fear of a double dip? That's interesting given the lack of past experience in double-dip cycles. Slowing growth? Surely that is not unlike how a freeway/motorway/autobahn congestion gets going, in fits and starts like any clunking chain or food-chain set of effects? There is concern about delayed (postponed) responses to the recession and credit crunch that may overhang recovery such as pent-up joblessness feeding through late to weaken consumer spending, and of course continuing strict credit controls by banks (their excuse for not expanding lending while actually shrinking it!). Uncertainty? What's now about that? Negativity on the economy? In a political election year in the US, nothing new about that either - government is the whipping boy. Credit issues? Why do banks view borrowers as bad credit risk in a recovering economy - actually because they still know themselves to be inconstant debtors. Lack of economic catalyst? Good one; where are the factors for sustained growth - why, in the governments economic recovery spending measures, but these are politically under attack, of course, and the customers of the market analysts reports tend to be fiscal conservatives always prepared to panic about tax and spend.
All we can conclude is that analysts are not outside of the general mess, but part of it, subject to the same subjective prejudices as anyone else - but that's not what we pay them for!
Historically, analysts lag behind events in revising their forecasts to reflect new economic conditions. Analyst forecast error is typically over-bullish — except during downturns, when it is too bearish. Analysts jobs when working for brokers is to encourage buying when the institutions are selling and vice versa - some cynics would say. In my view they are simply subject to the same information pressures as everyone else and have problems seeing the wood for the trees. Hence, as in all else, probably 10% of analysts are geniuses and the rest are dross.
As the graphic above shows, actual earnings from S&P 500 companies only occasionally coincide with the analysts’ forecasts. I expect the analysts' collective performance to be no better in other stock markets round the world, and they get time-scales wrong. As the chart shows, most of the time the analyst community is too bullish by double — they expect earnings growth of 10 to 12%, compared with actual earnings growth of 6%. We should be concerned perhaps that earnings recovery following a recession –like now — has analysts are under-estimating earnings. Lets assume this is because analysts are under-estimating the reluctance or slowness of firms to make new capital investments or build up inventories as they should, but that's only the corporate sector aspect - analysts don't know how, it seems, to look at demand factors in the wider economy.
Tuesday, 10 August 2010
DERIVING MORAL HAZARD IN DERIVATIVES
Buffett's Hathaway Trust profit was at $2bn down $1.3bn mid-2010 because of losses on derivatives. In 2008, the majority ($5bn) of JP Morgan's profit, and a third ($15bn) of Goldman Sach's in 2009 came from derivatives.
But, these will mainly be unrealised profit/loss. Banks may use paper profits to pay dividends, bonuses and fund share buy-backs, just as they may use paper losses to offset tax liabilities. This is so for all unrealised profit/loss and is treated no differently from realised profit/loss.
It would be interesting if we had a full-scale enquiry into the growth and role of financial derivatives. When derivatives profits are generated, who is bearing the counterpart losses? Is there too much concentration of derivatives among too few banks who can then bias the pricing of contracts? Would an exchange-traded system be fairer and a better market? Are derivatives far too big and dangerously so?
Derivatives are used for:
- high leverage/gearing, so a small movement in the underlying price causes a large difference in the contract value (not notional value) of the derivative, the gain to the investment price of the derivative contract (that can be a 100 times smaller than the notional value of the underlying)
- speculate to make a profit if the value of the underlying asset moves the way expected (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level) including falling in price that can be captured by short selling or an option
- hedge or mitigate risk in the underlying, by a contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out
- obtain exposure to an underlying that is not tradable e.g., weather derivatives, or without any actual connection to the underlying e.g. spread-betting
- optionability where the value of the derivative is linked to a specific condition or event (e.g., the underlying reaching a specific trigger price level).
A derivative is a contract between two parties with options to buy or sell (call or put) or an insurance cover or guarantee with a contract value based on the underlying's past (VaR estimate) and future price fluctuations in the 'cash market' (by which is meant any primary or secondary market trading the underlying directly), with the most notable being currency, interest rate, credit swaps, futures, and options generally. A derivative can be a derivation of any financial security, the scope is therefore endless. If we think vertically, then derivatives are the pricing and trading of contracts in all of, or only part of, underlying financial 'instruments' (tradable securities).
The underlying can have several features such as principle and interest, share and dividend, investment and return, and these elements can be separated and covered by derivatives.
Derivatives are therefore a combinations of insurance and speculative highly leveraged betting. It is the leverage available that appears to create moral hazard. When banks in the USA and UK were generating 45% of all corporate profits, some serious urgent thinking was required about the imbalance this created in the economy. and the moral hazard of any one sector making so much out of so little?
In insurance it is axiomatic that insurers have to keep an eye on the fundamentals, on the risk factors that trigger insurance claims. In banking where loans are not tradable or readily insurable, bankers also have to keep an eye on fundamentals. In both insurance and traditional bank lending a 'portfolio' risk margin is added to the cost of capital (deposit and funding rate) plus a profit margin. These margins only secure against expected 'normal' (through-the-cycle) defaults and claims and must also be competitive!
But, with the growth in reinsurance, securitisations of loan-books, loan insurance, property as collateral in a rising market, and credit derivatives, banks and some insurers could be more aggressive in their competitive pricing and ignore the fundamentals. Insofar as these 'derivatives' appeared to absorb all risks, and as decisions were increasingly automated, bankers and insurers became intellectually lazy, more specialised (narrow-focus), mere cogs, short term, and less truly customer-service oriented.
When the whole is impossibly complex and risky, the particular seems straightforward and safe.
Wholesale markets of secondary and tertiary traders and sub-insurers grew up where each would buy part of the risk and part of the premium and find ever new ways of leveraging large bets with small stakes. The portfolio principle operated in that the more any insurer or bank or investor could diversify their risks then the lower the probability of any big single loss at any one moment in time. But, on the same principle as the Adam Smith pin-factory, the Taylorist model, the Ford factory, banks and insurers divided their business into discrete specialised profit-centres where none could diversify except by use of derivatives. Since the late 1980s the fashion developed to see banking and insurance as a series of discrete processes that could learn from other industries like Fed-Ex for back office processing or Wal-Mart for retail selling or Visa for payments processing. Banks, insurers, universal banks and bancassurers became conglomerates of discrete businesses sharing an increasingly tenuous management control.
Where a management could manage one type of business such as a logistics business, a big bank's management could not manage a combination of many logistics, retail and wholesaling businesses. This is the best argument for breaking up the banks between retail and wholesale for example. But there are also counter-arguments, and these concern risk diversification. It is valid to say that a financial conglomerate is more diverse when it diversifies across all financial services. But, that does not mean it is diversified across all of the underlying economy and it begs the question of whether banking conglomerates know how to monitor and manage that diversification and if supervisory regulators and central banks know how to assess the matter.
The risk diversification of the whole has to be organised by the executive with effective oversight by the supervisory boards, followed by that of regulatory law, supervisors, and to some extent mutual members or shareholders and bondholders.
Derivatives grew at first with 'hedging'. Buyers of commodities could insure future prices they would get by buying simultaneous contracts to buy and to sell a commodity at or by a future date. Such contracts later developed for 'smoothing', rarely discussed, to place a limit on the impact on a firm, a long term contract, a project or a portfolio of interest or currency exchange or other price movements.
A big development since the 1990s was to use derivatives as a way of trading in or out of large 'cash' positions in the equities and bonds markets. To protect against triggering a large price change when selling a lot of shares of one stock or of many stocks the price impacts could be hedged in derivatives, or alternatively a loss in the cash market compensated by a profit in derivatives.
Once this awareness took root and institutions could use derivatives, hedging became matched and then eclipsed by speculative use of derivatives. Stock lending and repo swaps grew, and margin collateral to leverage loans, trade and investment volumes. And, just as odds on horses in a horse-race are directly influenced by punters' perceptions of the favourites to win, so too were prices of derivatives influenced by speculation as much as by hedging.
This is the only argument for not making over-the-counter derivatives exchange-traded unless you believe that just like in horse-races the market knows best and the balance of speculation is therefore intelligent pricing information.
In time the pricing of derivative in what appeared to be far more liquid markets came to influence the prices of the underlying instead of the other way about. Financial markets are not like horse-races, and not because in horse-racing you lose all of your stake, because you do that in derivatives, but because financial markets trade in price movements directly and this is equivalent to the flow of betting becoming a large determining factor in who wins the races.
But, unlike organised horse-races or fictional stories, financial markets do not have a beginning, middle and end, other than quarterly and annual reporting; punters can enter and leave with profit or loss at any time they choose!
Derivatives are like insurance, but also insurance that can dictate the price of the insured asset. As the cost of insuring certain loans rises or falls, such as in the Credit Derivative Spread, the value of those loans at market prices falls or rises. Rating Agencies have a major role in grading the riskiness of assets but are also led by perceptions in the markets, not what they are trusted to do, to focus only on fundamentals, hard when forecasting risk is required.
One of the outcomes of banks and others buying derivatives as insurance and as speculation is a growing disinterest in fundamental risk drivers.
If the price of buying insurance or the financial risk of derivatives speculation appears low relative to potential saving or gain, then why worry about fundamental micro or macro economic forecasting.
This is why banks have eshewed the advice of applied macro-economists in favour of mathematicians - all very well until there is a recession, and not a problem then unless there is a systemic collapse in the finance sector as a whole causing the great complexity of derivatives and derivatives of derivatives to fail to be honoured and fall apart, which is the Credit Crunch, but also The Great Wall Street Crash and several other spectacular collapses in economic history.
At a bank with an equally large insurance business where I was head of credit risk for both, I recall being asked a year before the Credit Crunch started and feeling perplexed by the board to evaluate all the bank's major insurers and reinsurers; are they sound, are we diversified or over-concentrated with any one firm, and what are our exposures to insurers individually and collectively? I'd known the problems at Lloyds of London in the 1990s, but the scale and risk of credit derivatives were at that time unknown to me. My view was that so long as we are aligned with what everyone else is doing and trusting we are not doing anything foolish - until I looked more carefully into the matter.
Derivatives are not stand-alone, but many other financial assets that are 'stand alone' have their prices influenced by the relative prices of other assets. In some respects all financial instruments are in part derivatives of each other, just as all assets are variously derivatives of loans or liabilities are derivatives of deposits, and assets and deposits influence each other.
The commonplace derivatives are swaps, futures and options, but in credit it is a form of insurance. My main concern at the bank and insurer was exposure to property and to the credit and economic cycle. I did not foresee the collapse of the wholesale funding market, partly because my bank did not operate on a highly leveraged balance sheet with a large funding gap and it did not have share-holders. But it did have 3% of the UK banking and 3% of the UK insurance markets, which is sufficiently substantial that it could not hide or withdraw from macro-economic consequences. It survived the credit crunch unscathed and coped well with recession, doubling its size with a judicious takeover.
But, these will mainly be unrealised profit/loss. Banks may use paper profits to pay dividends, bonuses and fund share buy-backs, just as they may use paper losses to offset tax liabilities. This is so for all unrealised profit/loss and is treated no differently from realised profit/loss.
It would be interesting if we had a full-scale enquiry into the growth and role of financial derivatives. When derivatives profits are generated, who is bearing the counterpart losses? Is there too much concentration of derivatives among too few banks who can then bias the pricing of contracts? Would an exchange-traded system be fairer and a better market? Are derivatives far too big and dangerously so?
Derivatives are used for:
- high leverage/gearing, so a small movement in the underlying price causes a large difference in the contract value (not notional value) of the derivative, the gain to the investment price of the derivative contract (that can be a 100 times smaller than the notional value of the underlying)
- speculate to make a profit if the value of the underlying asset moves the way expected (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level) including falling in price that can be captured by short selling or an option
- hedge or mitigate risk in the underlying, by a contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out
- obtain exposure to an underlying that is not tradable e.g., weather derivatives, or without any actual connection to the underlying e.g. spread-betting
- optionability where the value of the derivative is linked to a specific condition or event (e.g., the underlying reaching a specific trigger price level).
A derivative is a contract between two parties with options to buy or sell (call or put) or an insurance cover or guarantee with a contract value based on the underlying's past (VaR estimate) and future price fluctuations in the 'cash market' (by which is meant any primary or secondary market trading the underlying directly), with the most notable being currency, interest rate, credit swaps, futures, and options generally. A derivative can be a derivation of any financial security, the scope is therefore endless. If we think vertically, then derivatives are the pricing and trading of contracts in all of, or only part of, underlying financial 'instruments' (tradable securities).
The underlying can have several features such as principle and interest, share and dividend, investment and return, and these elements can be separated and covered by derivatives.
Derivatives are therefore a combinations of insurance and speculative highly leveraged betting. It is the leverage available that appears to create moral hazard. When banks in the USA and UK were generating 45% of all corporate profits, some serious urgent thinking was required about the imbalance this created in the economy. and the moral hazard of any one sector making so much out of so little?
In insurance it is axiomatic that insurers have to keep an eye on the fundamentals, on the risk factors that trigger insurance claims. In banking where loans are not tradable or readily insurable, bankers also have to keep an eye on fundamentals. In both insurance and traditional bank lending a 'portfolio' risk margin is added to the cost of capital (deposit and funding rate) plus a profit margin. These margins only secure against expected 'normal' (through-the-cycle) defaults and claims and must also be competitive!
But, with the growth in reinsurance, securitisations of loan-books, loan insurance, property as collateral in a rising market, and credit derivatives, banks and some insurers could be more aggressive in their competitive pricing and ignore the fundamentals. Insofar as these 'derivatives' appeared to absorb all risks, and as decisions were increasingly automated, bankers and insurers became intellectually lazy, more specialised (narrow-focus), mere cogs, short term, and less truly customer-service oriented.
When the whole is impossibly complex and risky, the particular seems straightforward and safe.
Wholesale markets of secondary and tertiary traders and sub-insurers grew up where each would buy part of the risk and part of the premium and find ever new ways of leveraging large bets with small stakes. The portfolio principle operated in that the more any insurer or bank or investor could diversify their risks then the lower the probability of any big single loss at any one moment in time. But, on the same principle as the Adam Smith pin-factory, the Taylorist model, the Ford factory, banks and insurers divided their business into discrete specialised profit-centres where none could diversify except by use of derivatives. Since the late 1980s the fashion developed to see banking and insurance as a series of discrete processes that could learn from other industries like Fed-Ex for back office processing or Wal-Mart for retail selling or Visa for payments processing. Banks, insurers, universal banks and bancassurers became conglomerates of discrete businesses sharing an increasingly tenuous management control.
Where a management could manage one type of business such as a logistics business, a big bank's management could not manage a combination of many logistics, retail and wholesaling businesses. This is the best argument for breaking up the banks between retail and wholesale for example. But there are also counter-arguments, and these concern risk diversification. It is valid to say that a financial conglomerate is more diverse when it diversifies across all financial services. But, that does not mean it is diversified across all of the underlying economy and it begs the question of whether banking conglomerates know how to monitor and manage that diversification and if supervisory regulators and central banks know how to assess the matter.
The risk diversification of the whole has to be organised by the executive with effective oversight by the supervisory boards, followed by that of regulatory law, supervisors, and to some extent mutual members or shareholders and bondholders.
Derivatives grew at first with 'hedging'. Buyers of commodities could insure future prices they would get by buying simultaneous contracts to buy and to sell a commodity at or by a future date. Such contracts later developed for 'smoothing', rarely discussed, to place a limit on the impact on a firm, a long term contract, a project or a portfolio of interest or currency exchange or other price movements.
A big development since the 1990s was to use derivatives as a way of trading in or out of large 'cash' positions in the equities and bonds markets. To protect against triggering a large price change when selling a lot of shares of one stock or of many stocks the price impacts could be hedged in derivatives, or alternatively a loss in the cash market compensated by a profit in derivatives.
Once this awareness took root and institutions could use derivatives, hedging became matched and then eclipsed by speculative use of derivatives. Stock lending and repo swaps grew, and margin collateral to leverage loans, trade and investment volumes. And, just as odds on horses in a horse-race are directly influenced by punters' perceptions of the favourites to win, so too were prices of derivatives influenced by speculation as much as by hedging.
This is the only argument for not making over-the-counter derivatives exchange-traded unless you believe that just like in horse-races the market knows best and the balance of speculation is therefore intelligent pricing information.
In time the pricing of derivative in what appeared to be far more liquid markets came to influence the prices of the underlying instead of the other way about. Financial markets are not like horse-races, and not because in horse-racing you lose all of your stake, because you do that in derivatives, but because financial markets trade in price movements directly and this is equivalent to the flow of betting becoming a large determining factor in who wins the races.
But, unlike organised horse-races or fictional stories, financial markets do not have a beginning, middle and end, other than quarterly and annual reporting; punters can enter and leave with profit or loss at any time they choose!
Derivatives are like insurance, but also insurance that can dictate the price of the insured asset. As the cost of insuring certain loans rises or falls, such as in the Credit Derivative Spread, the value of those loans at market prices falls or rises. Rating Agencies have a major role in grading the riskiness of assets but are also led by perceptions in the markets, not what they are trusted to do, to focus only on fundamentals, hard when forecasting risk is required.
One of the outcomes of banks and others buying derivatives as insurance and as speculation is a growing disinterest in fundamental risk drivers.
If the price of buying insurance or the financial risk of derivatives speculation appears low relative to potential saving or gain, then why worry about fundamental micro or macro economic forecasting.
This is why banks have eshewed the advice of applied macro-economists in favour of mathematicians - all very well until there is a recession, and not a problem then unless there is a systemic collapse in the finance sector as a whole causing the great complexity of derivatives and derivatives of derivatives to fail to be honoured and fall apart, which is the Credit Crunch, but also The Great Wall Street Crash and several other spectacular collapses in economic history.
At a bank with an equally large insurance business where I was head of credit risk for both, I recall being asked a year before the Credit Crunch started and feeling perplexed by the board to evaluate all the bank's major insurers and reinsurers; are they sound, are we diversified or over-concentrated with any one firm, and what are our exposures to insurers individually and collectively? I'd known the problems at Lloyds of London in the 1990s, but the scale and risk of credit derivatives were at that time unknown to me. My view was that so long as we are aligned with what everyone else is doing and trusting we are not doing anything foolish - until I looked more carefully into the matter.
Derivatives are not stand-alone, but many other financial assets that are 'stand alone' have their prices influenced by the relative prices of other assets. In some respects all financial instruments are in part derivatives of each other, just as all assets are variously derivatives of loans or liabilities are derivatives of deposits, and assets and deposits influence each other.
The commonplace derivatives are swaps, futures and options, but in credit it is a form of insurance. My main concern at the bank and insurer was exposure to property and to the credit and economic cycle. I did not foresee the collapse of the wholesale funding market, partly because my bank did not operate on a highly leveraged balance sheet with a large funding gap and it did not have share-holders. But it did have 3% of the UK banking and 3% of the UK insurance markets, which is sufficiently substantial that it could not hide or withdraw from macro-economic consequences. It survived the credit crunch unscathed and coped well with recession, doubling its size with a judicious takeover.
Monday, 9 August 2010
Derivatives Turbulence
Since late 2006, 384 financial services firms have 'imploded' in the USA, and a couple of hundred in other countries have closed. (see www.ml-implode.com)
Most were specialising in mortgages or over exposed to them. The listing of 'imploded' firms includes bankruptcy filing, temporary but open-ended halting of operations, or a "fire sale" of the firm. They include retail, wholesale, subsidiaries and entire companies.
With the massive downturn in the economy and slow recovery, banks needing to restructure their balance sheets are reluctant to lend, and are applying stricter credit conditions, probably until real growth and inflation both look persistent.
The high leverage of credit derivatives make them more fragile than ordinary funds
Goldman Sachs and Morgan Stanley each suffered at least 10 days of trading losses in the second quarter, underlining how turbulent markets have cast a pall on Wall Street since April, the FT reports.
On three occasions, Goldman’s traders posted shortfalls of at least $100m, while Morgan Stanley’s traders reported losses of between $50m and $75m twice, but never lost more than $75m on any one day. These daily losses are subsumed within monthly profits, so that the actual gross losses and profits are unknown. We can see some losses as reported by US commercial banks in the past.
GS and MS are among banks responsible for unreported risk, among 5 banks that failed to report hundreds of $billions of dollars in credit derivatives bought from foreign counter-parties in 2009, leaving those exposures below the radar of regulators in the US and Europe. The under-reported exposures to credit default swaps came to light as the US Federal Reserve and the Bank for International Settlements were preparing first-quarter reports of the industry’s lending and risk activities. It was revealed as a footnote to the BIS report’s lengthy tables (June 2010). “This underscores how little transparency there was and how much information was missing,” said one BIS official familiar with the report. The missing data concerns financial institutions that were hastily granted bank holding company status in 2008 as safe harbour action in the middle of the Credit Crunch - essentially so that the investment banks now registered as deposit-taking could resort to the Federal Reserve's liquidity window for short term financing as wholesale market liquidity evaporated. 
The failure in reporting underlines how the conversion to Fed-regulated banks also introduced those firms suddenly to a raft of complex bank reporting standards, and raises new questions on the lack of scrutiny they faced under previous regulators (the SEC).
The Fed, following a review of its quarterly report on cross-border risks, discovered that the group, which included Goldman Sachs, Morgan Stanley, American Express and CIT, only submitted claims on credit derivatives up to the amount where there was a corresponding position to hedge against. The additional risks, which totalled $400bn in the first quarter, were left out.
When in its recent quarterly return we see that GS earned 35% of its profits from derivatives, it is more than clear that hedging is only part of the reason for derivatives exposure and places question marks over how banks have netted their derivatives exposures to minimise capital reserve requirements, quite apart from the 'deouble-default' risk in a systemic crisis, which is shown up by the case described below of AIG.
BIS has pushed for transparency in the derivatives market, particularly that for instruments such as CDSs that are traded over the counter. Robert Rubin and Alan Greenspan successfully stopped credit derivatives from being subject to exchange clearing in 2000, soon after they had supported repeal of Glass-Steagal - two decisions that should have returned long before now to haunt them.
In a speech, Stephen Cecchetti, head of the monetary and economic department of the BIS, noted the events that threatened the world’s financial system in 2008 stemmed largely from the lack of knowledge about each bank’s risks. The Fed concluded the failure to report the derivatives positions stemmed from a lack of familiarity with requirements rather than any intentional move to withhold details.
Regulators plan now to update their 2009 cross-border risk reports to add the banks’ missing data.
Lehman Brothers books are taking years to net, recover and pay off, involving subsidiaries of Lehmans in many jurisdictions. But, at least the counterparties cannot sue on underwriting claims. By contrast, AIG's trading partners may force the now state-owned insurer to pay up for insured losses on corporate loans and mortgages for years, even decades, to come, complicating U.S. efforts to stabilize the firm.
European banks including Societe Generale SA and BNP Paribas SA hold almost $200bn in guarantees sold by AIG allowing the lenders to reduce the regulatory capital reserves against write-downs and for loan-loss provisions.
The firms may keep the contracts to hedge against declining assets rather than canceling them as AIG said it expects banks to do (according to David Havens, MD of Hexagon Securities LLC). He said, “For counterparties to voluntarily terminate those contracts makes no sense. There’s no question that asset values have soured on a global basis. With the faith and credit of the U.S. government backing those guarantees, why would they give that up?”
The falling value of holdings backed by the swaps may force AIG to post more collateral, stressing the insurer’s liquidity and credit ratings in ways that caused the firm’s collapse in Sept.'08, when AIG needed a U.S. bailout valued at $182.5bn after handing over collateral on a different book of swaps backing U.S. subprime mortgages.
As can be seen by the graphs derivatives contracts tend to be short term. The maturities for which AIG issued security guarantees appears absurd; how can the risks be quantified? God contracts for example shot up in the last couple of years in anticipation of fiscal uncertainties or anxieties. But this is trading on subjective or emotional or kneejerk opinion.
The average weighted term of the European swaps protection of residential loans is more than 25 years, and for corporate loans about 6 years (AIG regulatory filing). Contracts covering corporate loans in the Netherlands extend almost 45 years, and the swaps on mortgages in Denmark, France and Germany mature in more than 30 years.
The portfolio shrank by half in 15 months to $192.6bn by March 31.
AIG’s models show banks will abandon more contracts. It expects the banks to cancel “the vast majority” of contracts in the next year as regulatory changes reduce the benefits of the derivatives for lenders.
Last month, AIG said in a regulatory filing that it may be at risk for losses for “significantly longer than anticipated” if the banks don’t terminate their swaps. “Given the size of the credit exposure, a decline in the fair value of this portfolio could have a material adverse effect on AIG’s consolidated results”(AIG June filing).
The SEC asked for AIG to add the disclosure to the insurer’s “risk factors”.
RBS Group Plc, Banco Santander SA, Danske Bank A/S, Rabobank Group NV and Credit Agricole SA’s Calyon are also among banks that purchased the swaps. The banks could be forced to raise $10bn in capital if AIG fails (AIG June filing).
Santander said (to Bloomberg) through a spokesperson that the bank’s risk of an AIG failure is insignificant and fully collateralised. Calyon declined to comment (to Bloomberg). Representatives of the other lenders didn’t immediately return messages seeking comment.
Counterparties terminated or allowed to expire $27.8bn in the so-called regulatory relief swaps in the first quarter, and AIG got notice for another $16.6bn terminated in April. Some of the remaining swaps have suffered losses for which AIG posted $1.2bn in collateral as of the first quarter. Bloomberg reported, “You’ll have an increasingly toxic pool of credit-default swaps every quarter” as the least risky swaps are terminated, said Donn Vickrey, analyst at research firm Gradient Analytics Inc. “Swaps that are being held are done so for two reasons, either for regulatory relief or because they’re ‘in the money’” which means they are valuable hedges against asset declines.
Some of the swaps are no longer being held for regulatory relief, and AIG has reclassified $3bn in swaps through March 31 likely to be kept after regulatory benefits expire, with $393m liability against those swaps.
Gerry Pasciucco, hired by AIG in November to clean up the Financial Products unit that sold the swaps, said in an interview in December that the European swaps would mature over time without loss and faced very little risk. Pasciucco said in April that future losses will be limited. The $192.6bn figure for the swaps includes $99.4bn tied to corporate loans and $90.2bn linked to prime residential mortgages.
The analysts' view is that the size of the portfolio and the ‘black box’ nature of its underlying loans and assets mean that mark-downs in the regulatory CDS portfolio may prompt collateral margin calls that pressure AIG’s liquidity.
The US government’s rescue includes a $60bn credit line, $52.5bn to buy mortgage-linked assets owned or insured by the company, and investment of $70bn. AIG plans to reduce its debt under the credit line by $25bn by handing over stakes in two non-U.S. life insurance units. AIG has tapped about $43bn from the line as of July 15 '10.
Most were specialising in mortgages or over exposed to them. The listing of 'imploded' firms includes bankruptcy filing, temporary but open-ended halting of operations, or a "fire sale" of the firm. They include retail, wholesale, subsidiaries and entire companies.
With the massive downturn in the economy and slow recovery, banks needing to restructure their balance sheets are reluctant to lend, and are applying stricter credit conditions, probably until real growth and inflation both look persistent.
The high leverage of credit derivatives make them more fragile than ordinary funds
Goldman Sachs and Morgan Stanley each suffered at least 10 days of trading losses in the second quarter, underlining how turbulent markets have cast a pall on Wall Street since April, the FT reports. On three occasions, Goldman’s traders posted shortfalls of at least $100m, while Morgan Stanley’s traders reported losses of between $50m and $75m twice, but never lost more than $75m on any one day. These daily losses are subsumed within monthly profits, so that the actual gross losses and profits are unknown. We can see some losses as reported by US commercial banks in the past.
GS and MS are among banks responsible for unreported risk, among 5 banks that failed to report hundreds of $billions of dollars in credit derivatives bought from foreign counter-parties in 2009, leaving those exposures below the radar of regulators in the US and Europe. The under-reported exposures to credit default swaps came to light as the US Federal Reserve and the Bank for International Settlements were preparing first-quarter reports of the industry’s lending and risk activities. It was revealed as a footnote to the BIS report’s lengthy tables (June 2010). “This underscores how little transparency there was and how much information was missing,” said one BIS official familiar with the report. The missing data concerns financial institutions that were hastily granted bank holding company status in 2008 as safe harbour action in the middle of the Credit Crunch - essentially so that the investment banks now registered as deposit-taking could resort to the Federal Reserve's liquidity window for short term financing as wholesale market liquidity evaporated. 
The failure in reporting underlines how the conversion to Fed-regulated banks also introduced those firms suddenly to a raft of complex bank reporting standards, and raises new questions on the lack of scrutiny they faced under previous regulators (the SEC). The Fed, following a review of its quarterly report on cross-border risks, discovered that the group, which included Goldman Sachs, Morgan Stanley, American Express and CIT, only submitted claims on credit derivatives up to the amount where there was a corresponding position to hedge against. The additional risks, which totalled $400bn in the first quarter, were left out.
When in its recent quarterly return we see that GS earned 35% of its profits from derivatives, it is more than clear that hedging is only part of the reason for derivatives exposure and places question marks over how banks have netted their derivatives exposures to minimise capital reserve requirements, quite apart from the 'deouble-default' risk in a systemic crisis, which is shown up by the case described below of AIG.
BIS has pushed for transparency in the derivatives market, particularly that for instruments such as CDSs that are traded over the counter. Robert Rubin and Alan Greenspan successfully stopped credit derivatives from being subject to exchange clearing in 2000, soon after they had supported repeal of Glass-Steagal - two decisions that should have returned long before now to haunt them.
In a speech, Stephen Cecchetti, head of the monetary and economic department of the BIS, noted the events that threatened the world’s financial system in 2008 stemmed largely from the lack of knowledge about each bank’s risks. The Fed concluded the failure to report the derivatives positions stemmed from a lack of familiarity with requirements rather than any intentional move to withhold details.
Regulators plan now to update their 2009 cross-border risk reports to add the banks’ missing data.
Lehman Brothers books are taking years to net, recover and pay off, involving subsidiaries of Lehmans in many jurisdictions. But, at least the counterparties cannot sue on underwriting claims. By contrast, AIG's trading partners may force the now state-owned insurer to pay up for insured losses on corporate loans and mortgages for years, even decades, to come, complicating U.S. efforts to stabilize the firm.European banks including Societe Generale SA and BNP Paribas SA hold almost $200bn in guarantees sold by AIG allowing the lenders to reduce the regulatory capital reserves against write-downs and for loan-loss provisions.
The firms may keep the contracts to hedge against declining assets rather than canceling them as AIG said it expects banks to do (according to David Havens, MD of Hexagon Securities LLC). He said, “For counterparties to voluntarily terminate those contracts makes no sense. There’s no question that asset values have soured on a global basis. With the faith and credit of the U.S. government backing those guarantees, why would they give that up?”The falling value of holdings backed by the swaps may force AIG to post more collateral, stressing the insurer’s liquidity and credit ratings in ways that caused the firm’s collapse in Sept.'08, when AIG needed a U.S. bailout valued at $182.5bn after handing over collateral on a different book of swaps backing U.S. subprime mortgages.
As can be seen by the graphs derivatives contracts tend to be short term. The maturities for which AIG issued security guarantees appears absurd; how can the risks be quantified? God contracts for example shot up in the last couple of years in anticipation of fiscal uncertainties or anxieties. But this is trading on subjective or emotional or kneejerk opinion.
The average weighted term of the European swaps protection of residential loans is more than 25 years, and for corporate loans about 6 years (AIG regulatory filing). Contracts covering corporate loans in the Netherlands extend almost 45 years, and the swaps on mortgages in Denmark, France and Germany mature in more than 30 years.The portfolio shrank by half in 15 months to $192.6bn by March 31.
AIG’s models show banks will abandon more contracts. It expects the banks to cancel “the vast majority” of contracts in the next year as regulatory changes reduce the benefits of the derivatives for lenders.
Last month, AIG said in a regulatory filing that it may be at risk for losses for “significantly longer than anticipated” if the banks don’t terminate their swaps. “Given the size of the credit exposure, a decline in the fair value of this portfolio could have a material adverse effect on AIG’s consolidated results”(AIG June filing).The SEC asked for AIG to add the disclosure to the insurer’s “risk factors”.
RBS Group Plc, Banco Santander SA, Danske Bank A/S, Rabobank Group NV and Credit Agricole SA’s Calyon are also among banks that purchased the swaps. The banks could be forced to raise $10bn in capital if AIG fails (AIG June filing).
Santander said (to Bloomberg) through a spokesperson that the bank’s risk of an AIG failure is insignificant and fully collateralised. Calyon declined to comment (to Bloomberg). Representatives of the other lenders didn’t immediately return messages seeking comment.
Counterparties terminated or allowed to expire $27.8bn in the so-called regulatory relief swaps in the first quarter, and AIG got notice for another $16.6bn terminated in April. Some of the remaining swaps have suffered losses for which AIG posted $1.2bn in collateral as of the first quarter. Bloomberg reported, “You’ll have an increasingly toxic pool of credit-default swaps every quarter” as the least risky swaps are terminated, said Donn Vickrey, analyst at research firm Gradient Analytics Inc. “Swaps that are being held are done so for two reasons, either for regulatory relief or because they’re ‘in the money’” which means they are valuable hedges against asset declines.Some of the swaps are no longer being held for regulatory relief, and AIG has reclassified $3bn in swaps through March 31 likely to be kept after regulatory benefits expire, with $393m liability against those swaps.
Gerry Pasciucco, hired by AIG in November to clean up the Financial Products unit that sold the swaps, said in an interview in December that the European swaps would mature over time without loss and faced very little risk. Pasciucco said in April that future losses will be limited. The $192.6bn figure for the swaps includes $99.4bn tied to corporate loans and $90.2bn linked to prime residential mortgages.
The analysts' view is that the size of the portfolio and the ‘black box’ nature of its underlying loans and assets mean that mark-downs in the regulatory CDS portfolio may prompt collateral margin calls that pressure AIG’s liquidity.
The US government’s rescue includes a $60bn credit line, $52.5bn to buy mortgage-linked assets owned or insured by the company, and investment of $70bn. AIG plans to reduce its debt under the credit line by $25bn by handing over stakes in two non-U.S. life insurance units. AIG has tapped about $43bn from the line as of July 15 '10.
Friday, 6 August 2010
ITEM FOR WOMEN BANKERS - DEBRA'S CASE
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The voluptine Debrahlee Lorenzana claims that her ex-employers in the Chrysler Building forbade her "to wear sexy garments or high heels because they distract" her male colleagues. “I can not help it that I’m curvacious,” she told reporters for NY Daily News, which just loved the story. “And I am not about to go overeat to gain fifty to one hundred pounds simply because my employer wants me to be like everyone else.” The media have classed her as a babe that was too hot for Citigroup to handle.
The story is no sillier than a lot that goes on in celebrity magazines. The 33-year-old "eye-candy from Queens" filed suit in Manhattan Supreme Court. She alleged she was directed to refrain from turtlenecks, pencil skirts and tailored suits because clingy garments attracted excessive attention on the job. 
The presumption seems to be that Citicorp managers considered productivity suffered, hurting someone's bottom line - the inverse of what 'sexiness' is more often assumed to deliver positively to productivity? 
If sexiness is economically damaging by being distracting, or only in banking, there is a lot to be questioned about office work or in a bank branch.Her attorney, Jack Tuckner said, “Debrahlee Lorenzana might possibly be very appealing in anything she wears.” Tuckner works for Tuckner Sipser Weinstock & Sipser and clearly find Debra's deportment productive in his firm, as does whoever she now works for.Feminism continues to debate the physical objectification of sexiness figurined as female.
Post-modern post-feminism has no problem with that, but that's like saying bankers have no problem making money from asset bubbles. Bankers (not just the men) anyway are not feminist or even post-feminist, not an issue in a money-culture. Banks have a well populated history of losing 'constructive dismissal' suits as their kneejerk response to internal complaints of gender-bias and sexism etc. Citigroup, was the employer of a Debra, a Latino terminated for being unwilling to dress down in mid-town New York. 
A tearful Debrahlee Lorenzana read a prepared statement explaining why she is a victim of sex discrimination and asking for a human rights investigation. She claims she was fired as a business banker at Citibank after complaining that male colleagues called her good looks distracting. What males complain about that? She says something that is certainly not post-modern or post-feminist, that being beautiful is a curse for her and always has been, because people attribute her achievements to her looks, so she's had to work twice as hard to get ahead, which is not an argument that I can follow. She says she can't win though hopes to by suing Citibank for firing her for being too sexy.
Citibank certainly is accused of questionable actions — male managers pulling her aside and giving her a list of prohibited clothes and firing her for being late on dates that checked out to be weekends. She is not helping the case by her idea that she's just too beautiful - although I can think of some ugly male bankers who got to the top like Dick Fuld, generally prettiness gets there too - but other than in sales and PR it is not a major factor surely? In letter she wrote to Citibank's HR department she said, "Other female employees were able to wear such clothing because they were short, overweight, and they didn't draw much attention, but since I was five-foot-six, 125 pounds, with a figure, it wasn't 'appropriate'. . . . Are you saying that just because I look this way genetically, that this should be a curse for me." Apparently she's five-foot-eight according so some press coverage, but otherwise she could be telling the exact truth here, except the genetically bit has been augmented as proven by a video found by the voracious press in which when a single-Mom insurance agent she went to get a DD to become two boobs on a stick in her words, like Pamela Anderson and to find her own Ben Affleck, an how plastic surgery is the "best thing ever" and commonplace nonsense like that?
At JP Morgan Chase the rumour is that she'll be sacked there too this time for talking too much to the press! Her lawyer says if JPM&C sack her they'll sue that bank also. Her new boss has tried to get Debra to cancel television interviews.
In the complaint against Citigroup, Debra claims that she was not properly trained and that she was "a target" to her colleagues. That is interesting - lack of formal training. She says she was a victim of sex discrimination and then retaliation for speaking up.
I wonder what she can possibly imagine getting compensation, not even distress since she appears to relish the publicity and does not appear to have suffered significant loss of earnings, except of course legal fees. 
The fed-up femme fatale made a formal complaint to Citigroup's HR in May last year, and asked for a transfer, which she got in July. But at the new branch she was chided for failing to recruit new customers and was dismissed in August last year. When the case came to court her gender-discrimination suit was dismissed because her contract with Citibank called for any disputes to be settled in private arbitration.
Ms Lorenzana, who wore a sleeveless black dress, during the televised interview, repeated her claims that Citibank allegedly canned her for wearing sexy outfits at work.
Monday, 29 March 2010
USA HOUSEHOLD WEALTH AND DEBT
In 2000, USA household wealth was $44 trillion and rose to $65 trillions in 2007 or equal to 108% of world GDP or twice the value of world trade or 4 times the world's energy consumption by $ value. It fell by $18 trillions and has recovered $5 trillions, though debt has fallen little. Household debt was 20% of USA household wealth in total and then rose to 28% before improving to 24%. But that's only the average. A fifth of the population or of households are too poor to have bank debts. Half the population had net wealth and now don't. Som will be dwelling on a 'lost decade' if they only think in money terms? 
They're the so-called middle class that both parties remain desperate to help and woo for votes. The Democrats also want to do something for the poor at least in health care insurance reform.The USA has about one third of world wealth and a similar proportion of world output. Roughly 10% of the population own 70% of US wealth, top 1% own 40%. The bottom 40% owned less than 1% of the nation's wealth, half of whom own nothing valuable!
When it comes to debt that is not distributed in the same proportions as wealth, but will be concentrated in the middle of the US household population.
Do not assume that income tax is exactly proportionate to wealth distribution either. The top richest 1% pay 33% of federal income tax; the next 9% pay another third; the next 15% pay 22% of the income taxes; and the next 25% pay 33% of income tax. The next 10% pay 3% and the last 40% pay no income tax, but a lot of sales tax and local taxes for which they get something in return, maybe most of it somehow, let's hope so. The US has a progressive tax structure which taxes less for smaller incomes. But the US does not directly tax wealth except the estate tax (what in UK is called death duties and inheritance tax).A quarter of households retain net wealth and are rich of which the top fifth (5% of all households) had under 10% loss. The top 1% may feel that in real terms or at least relative to everyone else they are in serious profit gains from buying distressed assets at discounts that will do well for them and their heirs in the future?
Thursday, 11 March 2010
CONTRACTS FOR DIFFERENCE? SOLD SHORT?
CBOT Floor - Credit default Swaps (CDS) and Contracts for Differences (CFDs), similer to put options, are major tools of 'short-selling' generally (which depends on stock lending), are employed on a large-scale by hedge funds, but also by medium to small brokers, and by individuals speculators, and were at the heart of the relentless fall in bank shares especially in the two years after June 2007 when the bottom fell out of the markets followed by the credit bottoms falling out their trousered-economies. CFDs are a leveraged way of participating in short-selling to profit from loss of market price in stocks, and as importantly, a way to profit from how short-sellers can cause stocks to fall in price! Many small sell-orders can drag a price down far more effectively than one much bigger sell-order.
The blame for the credit crunch (that triggered an Anglo-Saxon recession by pricking the asset bubbles of credit-boom economies) is a long list that includes:Sub-prime, self-certified, and buy-to-let mortgages sold to over-indebted borrowers;
Bugs in models of credit ratings agency that caused the models to be indifferent to defaults data and rate many Asset Backed Securities (ABS) far too highly;
Asset price weakness of Collateralized Debt Obligations (CDOs, also called ABS) when the bonds were offered into secondary markets that proved to be illiquid;
Credit Default Swaps (CDS) insurance-style derivatives on CDOs, and their further derivatives calls CDS Squared (CDSS);
Banks' inadequate levels of capital reserves, and their large 'funding gaps', which are banks' borrowings needed to fill the gaps between customer deposits and loans;
General accusations of weak regulation in an era of too-cheap money (low central bank discount rates);
Credit-boom economic growth policies in USA, UK and some other OECD countries such as Spain, Ireland, Greece, that also caused extreme imbalances in world trade;
Investor exuberance and blinkered risk-taking as property prices outpaced every other route to getting richer;
Extreme bias in bank lending in credit boom economies towards mortgages, property and consumer credit.
I could add other factors. But, surprisingly short selling, stock lending and CFDs have been treated as a tertiary symptom rather than also a major problem? A temporary ban was implemented on 'naked' short selling.
This had limited effect because the rules totally misunderstood how short selling works to drag down stock prices. Note that short-selling and the equivalent of CFDs have been available for a century as a speculative way to profit iCFD short-selling, for example, was the lubricant for the German currency crash and hyper-inflation of 1923, and continued to be used in subsequent currency crises round the world - and in some minds especially in 1993 attack on sterling forcing it out of the EMS, called Black Wednesday. Shorting interest rates is well established.
We see this again today in a sequence of sovereign debt crises and currency attacks. Traders are using every bit of political-economic news to perturb the markets, and sovereign debt is the current game of choice - why, because it can appear to the simple-minded to cover everything else in a national currency economy, which of course it does not really do so. 
Market regulators excuse call & put options, CFDs, in money market, bond and equities short selling as mostly legitimate risk hedging and also brokers need to maintain market liquidity by borrowing stock to sell when they are short of the stock, and so on. Hedge Funds and others have made $ billions of gains from asset price losses of longer term investors - one argument is that at least much of the value lost has been encashed and lost absolutely? The question is whether this is a source of sever systematic instability that should be checked. In defence of this lucrative activity, described by some as 'shooting turkeys in a barrel', various studies have been commissioned and published to show that profiting on the downside of markets is good, balancing, has little negative impact on prices, and is simply necessary! 
But, in crises when markets are volatile or obviously sliding, and when markets are nervous, easily moved by rumours and titbits of negative news, and when short term profit-takers out-weigh long term investors, then it becomes absurd to defend short selling or to assume that it is price-neutral or market-neutral!At last there is some more determined action. A growing European consensus on the need for tougher regulation of CDS trading was reflected by Lord Turner, chairman of the UK FSA, who warned that naked trading in corporate CDSs could force companies into default. FSA has also said it is investigating stock lending - especially to identify where stock-owners have not been advised that there stock may be loaned out - to garner a fee for custodians - when the liklihood is that the stock will be returned worth less, like letting a hotel room to a rock band and getting it back trashed. A first-order problem is getting data on what's been going on for years and what is happening now?
Regulators in the US, Hong Kong and EU have outlined new reporting measures on short selling of equities while at same time trying to preserving liquidity benefits generated at the margin by short selling i.e. they seek to constrain the short term speculation. Europe and HK want more timely disclosure of short selling activity, America’s SEC is backing a rule that is resisted by traders who say it will detract from liquidity. The new rule seeks to block short selling if a stock falls at least 10% in one day. How that can practically operate is unclear. A Franco-German initiative, backed by Luxembourg and Greece, calls for regulators to be given “unlimited access” to a register of derivatives trading in order to identify who is trading and what they are doing. It proposes that derivatives transactions should only be allowed on exchanges, electronic platforms and through centralised clearing houses. Credit Default Swaps (CDSs) and CFDs are commonly used by banks and hedge funds to reduce their risk, but they are also popular with investors who buy and sell them with an eye to quick profit. Naked CDS and CFDs drove down Greek bonds this year and banks and financial companies last year, and the year before.
Lord Turner, who is also a member of the Financial Stability Board, which works on G20 global regulatory proposals. He wants regulators to look at the question of naked CDSs on both corporate and sovereign debt. “We need to think about whether we are being radical enough on credit default swaps . . . as to whether naked CDSs should be allowedd.” He is concerned that corporate CDSs can be easily manipulated to force a company into default, a form of market abuse. As before, however, hasty action is not advised! “We need to look at these issues very carefully. There is a danger of an oversimplistic belief that everything going on is shorting in the CDS market.”
Mario Draghi, chairman of the FSB, signalled this week that the group is focused on the issue. “This way of betting has systemic implications.The sense I have is that governments are increasingly uneasy with this. Whenever something has systemic implications, you can bet it is going to get systemic regulation.”
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