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Zhou-Bernanke phone call

2010-11-12T06:15:00.000-08:00

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.

ANALYSTS OVERSHOOT ECONOMICS

2010-09-01T02:15:00.000-07:00

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.

DERIVING MORAL HAZARD IN DERIVATIVES

2010-08-10T09:52:00.000-07:00

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.

Derivatives Turbulence

2010-08-09T22:27:00.000-07:00

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 fundsGoldman 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.

ITEM FOR WOMEN BANKERS - DEBRA'S CASE

2010-08-06T14:34:00.000-07:00

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.

READ MY LIPS

2010-03-29T16:00:00.000-07:00

USA HOUSEHOLD WEALTH AND DEBT

2010-03-29T15:21:00.001-07:00

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?

COUNTRIES OF THE WORLD BY GOVERNMENT BORROWING RATIOS TO GDP

2010-03-29T15:17:00.000-07:00

BANKS OF THE WORLD BY CUSTOMER LENDING

2010-03-29T15:16:00.000-07:00

CONTRACTS FOR DIFFERENCE? SOLD SHORT?

2010-03-11T04:00:00.000-08:00

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.”

Bankers Without a Clue by Paul Krugman

2010-01-20T11:44:00.000-08:00

NOT TOO BIG TO FAIL BUT TOO BIG TO FEEL!
First McDowell's comment: Bankers are not trained well and not trained in economics or history it seems - at least not the topmost bankers in charge of the biggest banks - this seems to be the impression that Paul Krugman gained from USA's Financial Crisis Inquiry Commission - it echoes similar impressions from the UK's House of Commons Finance Select Committee hearings. Read on. This cartoon, which I've added in here seems to say it all. NY Times: Published: January 14, 2010
The official Financial Crisis Inquiry Commission — the group that aims to hold a modern version of the Pecora hearings of the 1930s, whose investigations set the stage for New Deal bank regulation — began taking testimony on Wednesday. In its first panel, the commission grilled four major financial-industry honchos. What did we learn?
Well, if you were hoping for a Perry Mason moment — a scene in which the witness blurts out: “Yes! I admit it! I did it! And I’m glad!” — the hearing was disappointing. What you got, instead, was witnesses blurting out: “Yes! I admit it! I’m clueless!”
O.K., not in so many words. But the bankers’ testimony showed a stunning failure, even now, to grasp the nature and extent of the current crisis. And that’s important: It tells us that as Congress and the administration try to reform the financial system, they should ignore advice coming from the supposed wise men of Wall Street, who have no wisdom to offer.
Consider what has happened so far: The U.S. economy is still grappling with the consequences of the worst financial crisis since the Great Depression; trillions of dollars of potential income have been lost; the lives of millions have been damaged, in some cases irreparably, by mass unemployment; millions more have seen their savings wiped out; hundreds of thousands, perhaps millions, will lose essential health care because of the combination of job losses and draconian cutbacks by cash-strapped state governments.
And this disaster was entirely self-inflicted. This isn’t like the stagflation of the 1970s, which had a lot to do with soaring oil prices, which were, in turn, the result of political instability in the Middle East. This time we’re in trouble entirely thanks to the dysfunctional nature of our own financial system. Everyone understands this — everyone, it seems, except the financiers themselves.
There were two moments in Wednesday’s hearing that stood out. One was when Jamie Dimon of JPMorgan Chase declared that a financial crisis is something that “happens every five to seven years. We shouldn’t be surprised.” In short, stuff happens, and that’s just part of life.
But the truth is that the United States managed to avoid major financial crises for half a century after the Pecora hearings were held and Congress enacted major banking reforms. It was only after we forgot those lessons, and dismantled effective regulation, that our financial system went back to being dangerously unstable.
As an aside, it was also startling to hear Mr. Dimon admit that his bank never even considered the possibility of a large decline in home prices, despite widespread warnings that we were in the midst of a monstrous housing bubble.
Still, Mr. Dimon’s cluelessness paled beside that of Goldman Sachs’s Lloyd Blankfein, who compared the financial crisis to a hurricane nobody could have predicted. Phil Angelides, the commission’s chairman, was not amused: The financial crisis, he declared, wasn’t an act of God; it resulted from “acts of men and women.”
Was Mr. Blankfein just inarticulate? No. He used the same metaphor in his prepared testimony in which he urged Congress not to push too hard for financial reform: “We should resist a response ... that is solely designed around protecting us from the 100-year storm.” So this giant financial crisis was just a rare accident, a freak of nature, and we shouldn’t overreact.
But there was nothing accidental about the crisis. From the late 1970s on, the American financial system, freed by deregulation and a political climate in which greed was presumed to be good, spun ever further out of control. There were ever-greater rewards — bonuses beyond the dreams of avarice — for bankers who could generate big short-term profits. And the way to raise those profits was to pile up ever more debt, both by pushing loans on the public and by taking on ever-higher leverage within the financial industry.
Sooner or later, this runaway system was bound to crash. And if we don’t make fundamental changes, it will happen all over again.
Do the bankers really not understand what happened, or are they just talking their self-interest? No matter. As I said, the important thing looking forward is to stop listening to financiers about financial reform.
Wall Street executives will tell you that the financial-reform bill the House passed last month would cripple the economy with overregulation (it’s actually quite mild). They’ll insist that the tax on bank debt just proposed by the Obama administration is a crude concession to foolish populism. They’ll warn that action to tax or otherwise rein in financial-industry compensation is destructive and unjustified.
But what do they know? The answer, as far as I can tell, is: not much.

CUSTOMER SERVICE OR NOT?

2009-11-05T19:29:00.000-08:00

Standard Bank asks customers for ideas on how it can improve servicE - surely an excellent idea and one that other banks embrace - but vociferously not Bank of America?
Submitted ideas are posted on the bank's site, enabling other customers to vote for them and add their own comments. Several ideas have been posted such as asking for a tool to track home loan applications, a small business networking facility and a change to the current "boring and annoying" call centre music. This is following the healthy example of HSBC First Direct in the UK which recently introduced a section, Talking Point, to its site where customers can leave an open message. The contrast could not be greater than Bank of America, one of the world's very biggest banks. BoA specifically asks people not to contact it with ideas and suggestions for customer service improvement. It states, "unsolicited idea submission policy - Bank of America and its associates do not accept or consider unsolicited ideas, including ideas for new or improved products, processes or technologies, product enhancements, advertising and marketing campaigns, promotions or new product names. Please do not send any original materials, suggestions or other items," and "If, despite our request not to send us your ideas, you still do, then regardless of what your communication states, the following terms shall apply to your idea submission. You agree that:
(a) your ideas will automatically become the property of Bank of America, without compensation to you,
(b) Bank of America can use the ideas for any purpose and in any way, and
(c) any information you provide will be considered non-confidential."
Of course, part of the problem is the litigious and rights culture of USA where if in fact someone posted an idea and it happened to coincide subsequently with a reform or innovation by the bank whoever submitted the exact same or roughly similar suggestion would have a viable claim for compensation reward, which in the US courts easily translates into many $millions at the behest of no-win no-fee greedy lawyers.

HOLLOW BULLET POINT BANKS

2009-09-28T04:29:00.000-07:00

Forget restoring Glass-Steagal, we should withdraw the legal right of financial services to advertise, granted to them in 1984. Collectively what it has cost banks to define themselves in a few mot justes must be the most expensive one line haiku poems ever, save perhaps those written by Mao Tse Tung or the Nazi 'Strength through Joy'?
You live. We'll take care of the details
(HypoVereinsbank, Germany Advertising slogan)
Always giving you extra / Get a little extra help from the Halifax (Halifax bank,UK, now HBOS Slogans. The Bank of Scotland previous slogan was: A friend for life!)
The bank for a changing world
(BNP Paribas Bank, European Ad slogan: BNP Paribas)
More ideas for your money / Turning banking on its head / Because life's complicated enough / Investments with Abbey endings/ Get the Abbey habit.
(Abbey National Bank, UK Slogans: Abbey)
The bank for sustainable development/ When your money is safe everything is too
(Dexia Bank, Belg/Lux)
The Bank in Your Mind
(GarantiBank International, Turkey Marketing slogan)
Britain's best business bank
(Allied Irish Bank Advertising slogan)
You and us / UBS. Here today. Here tomorrow.
(Union Bank of Switzerland - UBS Slogans)
360° Finance -It's time for an expert.
(Credit Suisse bank Slogans)
Whatever makes you happy
(Credit Suisse Private Banking tagline)
You first / Banking worth talking about
(Lloyds TSB banking Taglines)
The bank that likes to say Yes
(Trustee Savings Bank, now Lloyds TSB in LBG, Ad slogan)
Make it happen / Where people matter
(Royal Bank of Scotland Advertising slogans)Your Life. Anything is possible/ Be with AIB
(Allied Irish Bank Advertising slogan)
Fluent in finance / It's our business to know your business
(Barclays bank Slogans)
The right relationship is everything
(Chase Manhattan Bank Tagline)
Make it happen
(Commonwealth Bank of Australia, advertising slogan as part of RBS)
Save Your Money!
(ING Direct bank Marketing slogan)
Making more possible
(ABN AMRO bank Advertising slogan)
Life. Money. Balance both.
(Scotiabank, Canada, Motto)
Your Citi never sleeps/ Because the Citi never sleeps/ Live Richly/ The whole world in one bank. / Where money lives
(Citigroup/Citibank Slogans)
What's in your wallet?
(Capital One Bank Advertising slogan)
Higher Standards / Embracing ingenuity/ Think what we can do for you
(Bank of America Slogans)
Come and talk to the listening bank/ Together we make a great team
Midland Bank (founded 1836 and after 1992 part of HSBC group)
The world's local bank
(HSBC Bank, 5,500 offices in 79 countries, advertising slogan)
Advice you can bank on
(Dresdner Bank Tagline)
A passion to Perform./ Leading to results
(Deutsche Bank Ad slogans)
We value your time
(Centurion Bank, India, Motto)
The clean Swiss bank.
(COOP Swiss Bank Advertising slogan)
Good with Money/ Customer led, ethically guided/ Financially Sound, ethically sound - a bank with a difference
(Co-0p Bank, UK, taglines)
The power to do more
(Timesbank, India, advertising slogan)
The bank of South Australians
(BankSA, South Australia, marketing slogan)
Not Your Typical Bank
(Citizens Bank, USA, part of RBS group, advertising slogan)
The Thinking Behind the Money
(PNC Bank Tagline)
Ideas ahead
(Commerzbank, Germany Advertising slogan)
At the service of your ideas
UniCredit bank, Italy, advertising slogan)
Ask. Listen. Solve
(Commerce Bank, USA, Kansas, Missouri & Illinois, advertising slogan)
Uncommon Wisdom
(Wachovia Securities Corporate & Investment Banking Group, advertising slogan)
You're Not Just Another Customer. We're Not Just Another Bank.
(SouthTrust Bank, in 2004 SouthTrust merged with Wachovia, tagline)
More human interest
(Washington Mutual banking & financial services Ad slogan)
A Bank and popular at the same time
(Banque Populaire, France, advertising slogan)
How can we help you?
(First National Bank, South Africa, advertising slogan)
Solid partners, flexible solutions
(Fortis banking and insurance Advertising slogan)
Making every moment count
(Maybank, Singapore, Malaysia, advertising slogan)
The Next Stage in Banking
(Wells Fargo banking Marketing slogan)
Today. Tomorrow. Together
(Absa bank, South Africa Motto)
Where you know your banker and your banker knows you
(EvergreenBank, USA, slogan)
Five Star Service Guaranteed
(US Bank, marketing slogan)
Have the life you want. / It's easy to bank with AMP.
(AMP financial services, New Zealand, taglines)
Value from ideas
(Santander group banking, advertising slogan)
Milford's Best Bank!
(The Milford Bank, USA, motto)
How can we help you?
(SunTrust bank, USA, advertising slogan)
The relationship people
(AmSouth bank, USA, Ad slogan)
One client at a time.
(Morgan Stanley investment bank marketing slogan)
Another way/ To save and invest, talk to Natwest
(Natwest Bank taglines)
If you got this far you may wish to check out some of the problems with hollow bullet points? See: http://www.metacafe.com/watch/2576309/hollow_point_bullets_recalled_that_dont_explode_in_targets/
For a potted history of bank advertising see:
http://www.governmentalityblog.com/my_weblog/2009/08/the-big-money-a-short-history-of-financial-advertising.html

CREDIT DEFAULTS - WHERE ARE THEY TODAY?

2009-07-24T09:52:00.000-07:00

US credit risk default data needed for stress tests and scenarios, are likely to be repeated in the UK after a short lag of possibly only 6 months and in continental Europe 4 to 6 quarters thereafter.
American Bankers Association (ABA)- first quarter of 2009:
- Home equity loan defaults increased from 3.03% in Q4 2008 to 3.52% Q1 2009.
- Home equity line of credit defaults rose from 1.46% to 1.89 %.
- Credit card defaults from 5.52 % to 6.6 % ("% of $ debt outstanding" basis).
- Direct auto loan delinquency from 2.03% to 3.01%.
- Personal loan defaults from 2.88% to 3.47%.
These are record highs based on the aggregate consumer credit delinquency index of the ABA since 1974!
CORPORATE credit quality?
- default rate on sub-investment grade bonds quadrupled to 9.5 % from 2.4 % over 4 quarters (Fitch Ratings).
- S&P expects to downgrade over $235bn of CMBS.
Loose underwriting, falling asset prices, falling rents and rising vacancies are hitting the commercial real estate sector.
Vice President Joe Biden says the administration "misread the economy." The projection that unemployment would peak at 8 % — has been exceeded 9.5 % ... and a double-digit level is imminent. EU countries have experienced rates as high as 20% in recent decades. It is reasonable to expect the US OFFICIAL rate to peak somewhere between 10 and 15%. The Obama are talking about the possibility of a second economic stimulus package. This would be incorporated in the budget for the year beginning 1st October. The $787bn FISCAL boost from the budget beginning in February has not fully fed through the economy but will require probably more than the same again.

SHARES AT POSTAGE STAMP PRICES;WHY NOT GO FOR THE REAL THING?

2009-03-22T14:59:00.000-07:00

No-one is sure when the bottom will bottom in shares, lower new highs, lower lows, and no-one wants to overpay even when getting back into the market at obviously historical lows far below net book values. Our bank shares are now postage stamp prices, so I say why not buy the real thing? I favour stamp investments when they are like Bonds, but also a great inflation hedge and recession-proof investments. And, of course, no stamp-duty when buying 'forever' postage stamps. For those investors ignorant of the 'forever' jargon, this means a postage stamp stating first class or second class but not the class-price! Only 'forever stamps' are investment-grade! I just wish our banks paid as much as the annual gain on 'forever stamps' in retail deposit rates? The cost of sending a letter in UK will go up next year. First and second-class stamps are being increased by 3p to 39p and 30p from April. That's a heady 7.7% and 10% return if you buy now. This will be the second set of rises in 12 months after similar increases last April well above the rate of inflation never mind stratospherically above stock market returns. First class stamps back then went up by 2p to the current 36p and second class by 3p to the present 27p. Business customers will see average price rises of 4.2% (worth in total over £200m). The Royal Mail said that even after the rises, UK stamp prices would remain among the lowest in Europe. That means plenty more scope for rises. If you are a US$ dollar investor now might be a great time to buy UK stamps in expectation of additional currency exchange rate gain sometime later this year. In the UK, around five million fewer letters are being delivered every day compared with two years ago. Therefore, post offices will have many spare sheets, good as cash, better as they rise in value. This is a liquid market with less uncertainty than Gold. Stamps must have a big and ready market of willing buyers and willing sellers now that many post offices face closure threats. hence the prices have got to be 'fair value' and by buying stamps in their thousands it is a win-win for post offices and stamp-holder investors. In the USA, postage stamp rises are limited to the rate of consumer price infltion, hence the next rise like the last one is only about 2% (though 32% for a canny £ sterling investor back then) but for the US$ investor no currency gain. Long term if you could get Forever Stamps, not a bad return. Sending a letter will soon be a little more expensive in the U.S. Postal Service. The next 2% increase is effective May 11, 2 cents to 44 cents for a first class stamp. The total rise is worth about $billion, so not a market for big speculators. Stamps are like cash. Forever Stamps are like AAA bonds and franking machines are like treasury bills. You can buy "Forever Stamps" at the current 42-cent rate and make a 2% return in only 6 weeks or less guaranteed, even wait until the 10th and make the gain in 1 day. That's better than the banks are guaranteed to return on any day, but who knows when they might rebound and stay up?

ACHILLES HEEL OF CDS DEUS EX MACHINA

2009-03-05T07:04:00.000-08:00

Peter Paul Rubens - Achilles down at heel.
Following 2 blogs below, more on Gaussian copula and credit derivatives
In 2005, a WSJ article described the 5-year old maths equation that ballooned the market for credit derivatives to a nominal value issued that briefly exceeded all of world GDP in 2007. In 2005 the value of contracts outstanding was only 1/30 of what it grew to over only the next 3 years. That heady ascent alone should have sufficed for regulators, central banks, and governments to call an emergency stop to the topsy turvey madness and take drastic action - they didn't.
Credit derivatives let banks, hedge funds and other investors trade the risk associated with credit defaults (i.e. bankruptcy of bond issuers). As with other derivatives products, market size didn't take off on rocket trajectories until a simple model for pricing was widely accepted. The model itself that did this was without a scintilla of doubt far too simple, yet academics were guarded in their condemnations, and used their critiques mainly to publish more academic papers rather than scream out "Emperor has no clothes!". So, somehow, the doubts were only ripples in the market pond-life. From market-traders and securitizing bankers' perspective it improved risk valuations by simplifying (in proprietary ways) and yet maintained the fiction of the necessity to pay large telephone number bonuses to "sophisticated, complex, structured product" traders and research analysts. On the plus side, credit derivatives appeared to make bond markets more liquid and efficient, allowing "risk to be transferred to those most willing to bear it". On the downside, by 2005 it was already in the public domain from the views of many clear-sighted thinkers that this was supporting an ill-understood casino playing with trillions of dollars. The earlier generation of models coming out of the Vasicek model for default probabilities (the basis of the KMV methodology) looked ragged and stochastically rough. David Li's computerized financial model appeared to weigh the likelihood that a given set of corporate bond-issuers would default on their bond debt in quick succession, forming the long tail of a risk bell-shaped curve, the tail being the long downcurving end with a small % (unexpected, unlikely) probability of many simultaneous defaults (bankruptcies) occuring. Think of it as a produce scale that not only weighs a bag of apples but estimates the chance that they'll all be rotten in a week. The 2001 dot.com technology bubble burst was an example of this. And yet, that, and many other examples in previous years, was not enough to shed serious doubt on a simplistic risk algorithm, possibly because it appealed to financial mathematicians while financial economists were left entirely out of the loop.
The model fueled explosive growth in the market for credit derivatives: investment vehicles that based on corporate bonds to price and sell insurance protection against a default. This market that barely existed in the mid-1990s. By 2005 it seemed in WSJ's words "gigantic -- measured in the trillions of dollars -- and so murky that it has drawn expressions of concern from several market watchers. The Federal Reserve Bank of New York has asked 14 big banks to meet with it about practices in the surging market." This did lead to changes to Basel II regulations, but the practises nevertheless mushroomed incredibly.
The model David Li had devised helped estimate what return investors in certain credit derivatives should demand, how much they have at risk, and what strategies to employ to minimise the risk. Big investors started using the model to make trades that entailed giant bets (given, as with most derivatives, the opportunity to leverage hugely) i.e. with little or none of their cash-money tied up. By 2005, hundreds of billions of dollars were riding on variations of the model day by day.
In 2005, Darrell Duffie, a Stanford University professor, famous alongside Professors, Merton and Singleton for mathematical modeling of financial risks, said "David Li deserves recognition, he brought that innovation into the markets [and] it has facilitated dramatic growth of the credit-derivatives markets." But he recognised that the problem was that "the scale's calibration isn't foolproof. The most dangerous part." Hence the professors focused on more scalable version. Mr. Li himself said back then of the model, words that have been oft-repeated recently, the problem "is when people believe everything coming out of it." He knew that investors put too much trust in it or don't understand its subtleties (?) and may think they've eliminated their risks when they hadn't. The story of Mr. Li (see next blog below) and his model illustrated, according to the WSJ in 2005, "the peril of today's increasingly sophisticated investment world... extends far beyond its visible tip of stocks and bonds and their reactions to earnings or economic news... the largely invisible realm of derivatives... investment contracts structured so their value depends on the behavior of some other thing or event... credit derivatives play a significant and growing role... Endless trading in them makes markets more efficient and eases the flow of money into companies that can use it to grow, create jobs and perhaps spread prosperity", which seemed on balance to condone the market. But the WSJ also said, "investors who use credit derivatives without fully appreciating the risks can cause much trouble for themselves and potentially also for others, by triggering a cascade of losses", and quoted David Hinman, of Ares Management LLC, "I think this is a baby financial mania... Like a lot of financial manias, it tends to end with some casualties."
David Li's model needed a fertile context. The context was investment banks trying to replicate a version of the german Pfandbriefe market of bank bonds, bonds covered by a bank's balance sheet of corporate loans. This became the concept of pooling corporate bonds and selling off pieces of the 'asset pool', of loan-receivable such as lease-finance loans, and including the value even of buying and selling the tax liabilities attaching to lease-finance asset pools, and extending this to corporate loans, just as they had done with mortgages. Banks called these bond pools collateralized debt obligations, CDOs. By cracking this market, investment banks could take a lot of corporate lending business away from traditional commercial banks, and did so.
CDOs made bond investing less risky through diversification across a pool of many borrowers of different sizes and business sectors. Invest in one company's bonds and you could lose all. But invest in the bonds of 100 to 300 companies and one loss won't hurt much.
The pools, however, didn't just offer diversification. They also enabled sophisticated investors to boost potential returns by taking on a portion of the pool if it can be divided into sub-pools with different risk probabilities or into theoretical slices each with different risk protections. Banks cut the pools into slices, called tranches, including one that bore the bulk (first loss %) of the default-risk and several more that were progressively less risky.
Say a pool holds 100 bonds. An investor can buy the riskiest tranche because it offers by far the highest % coupon return, but also bears the first 3% or 6%, say, of any losses the pool suffers from any defaults among its 100 bonds. The investor who buys this is betting there won't be any such losses, or not enough not to buy it for its double-digit % returns. The investor might be a trader or a broker who believes it can be sold-on to less sophisticated buyers who are mesmerised by the 12%, 15% or even higher coupon, and crazily even more so for some short-term gamblers when the spreads widened as a sure sign of the coming crash - why, because they might still book a big multi $million gain and could then maybe take their bonus and make a run for it? Alternatively, an investor could buy a conservative slice, which won't pay as high a return but also won't face any losses until 10% or more of the pool's bonds default first, and in short to medium term that might appear unlikely. But, who knew? And, when looking for fee-spreads, when dealing with other people's money, who cared?
Investment banks, to figure the rates of return and thereby the price to offer each slice of the pool, they first had to estimate the likelihood of companies who debt is represented in the pool would all go bust at once and totally fail to honour their interest and repayment obligations? Their fates might be tightly intertwined, interdependent in the market, and secondarily the investors and financial firms involved might also be inter-networked. But that latter aspect failed to be quantified. If the corporate borrowers and bond issuers were all in closely related industries, such as automotive, they might fall like dominoes after some catastrophic event exclusive to the automotive industry. In that case, the riskiest slice of the pool would not offer a return much different from the more risk-protected slices, since anything that would sink two or three companies would probably sink many more. Such a pool would have a "high default correlation." But, if a pool had a low default correlation, a low chance of all its companies falling together, then the price gap between the riskiest and least-risky slices would be wide.
This is where Mr. Li made his contribution in 2001.
For four years, nobody knew how to calculate default correlations with precision. Mr. Li's solution drew inspiration from a concept in some actuarial life and pension policy risk research known as "broken heart", which observed that people tend to die faster after the death of a beloved spouse and this this death correlation could be quantitatively predicted, something quite useful to companies that sell life insurance and married-couple annuities. This kind of research has grown with many new companies entering the market for retailing health, life and pension policies. They wanted the agent-fees and faster growth from cherry-picking the least risky policy-holders. The essence of insurance is to build big enough pools that reflect the aggregate risks of what is known in national statistics. To improve on those meant growing faster. Building market share always has a cost a few years down the track of a sudden ballooning of claims. Cherry-picking seemed a way to mitigate this. The same thinking could be applied to CDS.
"Suddenly I thought that the problem I was trying to solve was exactly like the problem these guys were trying to solve," says Mr. Li. "Default is like the death of a company, so we should model this the same way we model human life." A fruitful context for this lateral way of thinking was the current fashion for finding zoological and biological metaphors to replace or augment the empirically-observed and testable precepts of Keynesian macroeconomic models that in the heyday of Monetarism were now politically abandoned if not discredited.
Li's colleagues' work gave him the idea of using copulas (correlated couplings): mathematical functions the colleagues had begun applying to actuarial science. Copulas help predict the likelihood of various events occurring when those events depend to some extent on one another. Among the best copulas for bond pools turned out to be one named after Carl Friedrich Gauss, a 19th-century German statistician. Li had moved to a J.P. Morgan Chase & Co. unit (before later joining Barclays Capital) where he published his idea in March 2000 in the Journal of Fixed Income. The model, known by traders as the Gaussian copula, was born. "David Li's paper was kind of a watershed in this area," said Greg Gupton in 2005, senior director of research at Moody's KMV, a subsidiary of the credit-ratings firm. "It garnered a lot of attention. People saw copulas as the new thing that might illuminate a lot of the questions people had at the time." To calculate the likelihood of coupled defaults in a bond pool, the model uses information about the way investors are treating each bond, how risky they're perceiving its issuer to be, if similar they may be linked. The market's assessment of the default likelihood for each company, for each of the next 10 years, is encapsulated in what's called a credit curve. Banks and traders take the credit curves of 9say) all 100 companies in a pool and plug them into the model.
The computer model runs the data through the copula function and spits out a default correlation for the pool - likelihood of all of its companies defaulting on their debt at once. The correlation would be high if all the credit curves looked the same, lower if not. But, of course, the correlations were abstract and unexplained and therefore entirely notional, predicated on s secondary or tertiary assumption that what looks the same is the same? By knowing the pool's default correlations, banks and traders can agree with one another on how much more the riskiest slice of the bond pool ought to yield than the most conservative slice. "That's the beauty of it," said Lisa Watkinson, who in 2005 managed structured credit products at Morgan Stanley in New York. "It's the simplicity." The irony of this is that what all those outside structured products considered opaquely complex, those inside thought of as beautifully simple. Those outside actually understood that the simplicity was inexplicable, but they were real bankers not mathematicians, and empirical economists, not theoretical drawers of curves, frontiers, and crossing points.
Because the model, by making it easier to create and trade CDOs, helped bring forth a factory mass-production of new products whose behaviour it can predict only abstractly and derivately, not with real-world precision, the effect was really to grow 'unknown' risk.
The Gaussian Copula Model managed to make Donald Rumsfeld, the Secretary of Defence at the time, sound supremely intelligent by comparison, when he said, "There are known knowns. There are things we know that we know. There are known unknowns. That is to say, there are things that we now know we don’t know. But there are also unknown unknowns. There are things we do not know we don’t know." The CD Swaps are like insurance policies. They insure against a bond default. Owners of bonds can buy credit-default swaps on their bonds to protect themselves. If the bond defaults, whoever sold the credit-default swap is in the same position as an insurer and has to pay up. AIG, one of the world's biggest insurers and the most ambitious jumped on the CDS market determined to dominate it and thereby become truly the world's largest insurer, which it did by an Irish country mile. The price of this protection naturally varies, costing more as the perceived likelihood of default grows. Some people buy credit-default swaps even though they don't own any bonds. They buy just because they think the swaps may rise in value. Their value will rise if issuers of the underlying bonds starts to look shakier. Hence, when in mid-2005 when housing prices started to fall and there was talk of a looming downturn, the prices of CDS took off and so too did the issuance, a case of excess supply growth not causing price deflation! Short term speculators outpaced insurance buyers. As spreads widened that in turn signaled to the markets that defaults and general economic downturn was increasingly imminent. This fed back into the CDS market and speculators weighed in even heavier. It was the equivalent of a massive short-selling signal, but the CDS speculators wanted desperately to make the biggest possible profits and that meant holding until just after the underlying stock markets and general economy would begin crashing.
Say somebody wants default protection on $10 million of GM bonds. That investor might pay $500,000 a year to someone else for a promise to repay the bonds' face value if GM defaults. If GM later starts to look more likely to default than before, that first investor might be able to resell that one-year protection for $600,000, pocketing a $100,000 profit. Hold on longer and the margin becomes 1,100bp i.e. $1.1m (as currently on many corporate bond CDS) but what's the value if the insurers look like they'll go bankrupt first, before claims are accepted and settled? AIG went bust and was shored up by the US Treasury in September 2008 just after Lehman Brothers failed.
Just as investment banks were pooling bonds into CDOs and selling off riskier along with less-risky slices, banks (beginning with ABN-AMRO) were pooling batches of CDS into Synthetic CDOs and sell slices of those. Because the SCDOs don't contain any actual bonds, only CDO insurance claims, banks can create them without going to the trouble of purchasing underlying bonds. And the more SCDOs they create, the more money the banks can earn by selling and trading them.
SCDOs have made the world of corporate credit very financially casino-sexy, high risk high return with little money up front. Someone who invests in a SCDO's riskiest slice, agreeing to protect the pool against its first $10 m in default losses, say, might receive immediate payment up front of $5m plus $500,000 a year, for taking on this risk. He would get this $5m without investing anything, just for the pledge to pay in case of a default, like an insurance company does, with the insured trusting that the risk will be underwritten by sub-insurers. Some investors, to prove they can pay if there is a default, might have to put up some collateral, but that might be only 15% or so of the amount they're on the hook for, or $1.5 million, giving a clear short term profit.
This confidence-trick setup makes SCDO investment very tempting formany hedge-funds that are predicated on highly-leveraged risk-taking. "If you're a new hedge fund starting out, selling protection on the [riskiest] tranche and getting a huge payment up front is certainly something that's going to attract your attention," said Mr. Hinman of Ares Management. It's especially tempting given that a hedge fund's manager typically gets to keep 20% of the fund's bookable profit annually.
SCDOs were booming massively in late 2005, and largely displacing the older-fashioned CDOs. Whereas in 2001, SCDOs insured less than $400bn face amount value of U.S. corporate bonds, they covered $2tn by the end of 2005 (source: J.P. Morgan Chase).
By the end of 2008, the size of the CDO market was $50tn in December 2008 (source: IMF - down from $54.6tn in mid-2008, and from $62tn at end-2007). Hugh McLernon, IMF Director says, "This is a commonly stated figure - it's been stated by the banks, rating agencies, regulators". He did also say, "even if they are nearly accurate, it dwarfs the GDP of the entire world by a couple of times", which, er, it doesn't (world GDP = $62tn) but that's what happens with astronomical numbers.
CDOs are investment products that bundle debt into tranches with the same rating, which when highly-rated pay a 1-2% premium and are sold to investors in the form of credit swaps, contractual bets between two parties about whether a third party will default on its debt. The associated companies listed in many of these products include major US financial firms caught up in the credit crunch, such as Countrywide, Lehman Brothers, Bear Stearns, Fannie Mae and Freddie Mac. According to McLernon, if seven or more of the 100 associated entities fail, investors will suffer heavy losses that will trigger "unprecedented litigation" including class action suits. Hence, when several of the entities commonly listed in these contracts failed, they were immediately saved or resuscitated by the US Treasury and are now called 'zombie banks', with the exception of Lehman Brothers, the decision not to save it now being deeply regretted by the US Treasury and many others. Mclernon said, "It depends, but on average, if the number of defaults goes to seven you lose one-third of your money, if it goes to eight, you lose two-thirds and if it goes to nine, you lose the lot." He also noted that it would be difficult to predict the extent of the potential fallout because of the lack of transparency in the derivatives market. "This area is noted for the fact that it's not transparent. No-one has a clue around the world - including the banks or the regulators. No-one has a clue what the amount in value of CDOs is, who's got them, when they are due to mature, what the terms of them are, and what will cause a total loss," and "God only knows - or maybe even he doesn't. I certainly don't." Therefore, the solution being worked on for over a year is to bring all CDOs and SCDOS on exchange via major clearing houses in the USA and Europe.
"I wouldn't want to be sitting on a list of these companies wishing that three or four more don't fail... I mean, if it hadn't been for the US government intervention ... which turned out to be an extraordinary one, they'd have all failed already." In 2005, the U.S. corporate-bond market has been stated by ratings agencies and others as $4.9tn and $3.6tn in early 2007 and $4tn in 2009. Actually, the truer figure is $13tn in 2005 and the European corporate-bond figure in 2005 was $7tn. These are both data source and definitional confusions. But, they show just how perplexing the analytics of the market can be. By mid-2006 for example the US Corporate bond market was said by some to be half the size of the European market, while US securitized bonds were 5 times the size of European securitized bonds. The confusion arises with defining what is a cash-market bond and what are derivative bonds such as CDOs. All tradable cash-market bonds must be registered on stock exchange even though most of the trading in them is off-exchange. Sometimes the confusion is between the size quoted for the trading volume estimates (secondary market), the value of the outstanding issues, and the value of new issues (primary market) or net new issues (issues less bonds that have matured).
Given all these problems of lack of transparency and in determining just the actual size of outstandings, turnover, and new issues, plus pricing, including the increasingly detached pricing of CDS and SCDS markets, even though these latter are used as proxies for the pricing of underlying bonds, and trying to track default rates, never mind too the downgrading of bonds by the ratings agencies, then all of that also causes confusion. Downgradings were running at less than 3% of issues, then about 3-4% and now 8-10% a year in some or all classes; we can't be absolutely sure.
Consequently, given the amount of conflicting noise, and despite the now well-recognised shortcomings of Mr Li's GCM, if in the credit crunch and recession all classes are correlating towards similar default rates as increasingly all debts appear inter-dependent, then ironically the GCM that caused much of the problem becomes more reliable, at least in the absence of any other reliably authoritative guides. The double-irony however is that CDS and SCDS spreads predicated on GCM are self-fullfilling i.e. have become part of a self-debilitating downward spiral, the ultimate short-selling deus ex machina!
Much of the world's private and public financial assets are directly and indirectly riding on Mr. Li's model, which he freely conceded 4 years ago had important flaws. For one, it merely relies on a snapshot of current credit curves, rather than taking into account the way they move. It has limited historical data including no full-cycle data. We are getting that only now in extremis. The result: Actual prices in the market differ widely from what the model indicates they would or should be!
Investment banks try to compensate for the shortcomings of the model by cobbling copula models together with other, proprietary model adjustment methods. But, while this is especially active today, it has been going on for years! At J.P. Morgan, 4 years ago, Andrew Threadgold, Head of Market Risk reported, "We're not stupid enough to believe [the model] is omniscient... All risk metrics are flawed in some way, so the trick is to use a lot of different metrics." Bank of America and Citigroup representatives also said they were using various models to assess risk and constantly working to improve them. Deutsche Bank had no comment. Moody's woke up in early 2007 to the fact that their risk-grading models were indifferent to changes in default data! When they fixed that by mid-year, their ratings on ABS and CDO bonds on re-calculation dropped anything up to 17 risk grades, from top AAA to lowest junk-bond status!
As with any model, the forecasts investors, issuers, raters, traders make by using the model are only as good as the inputs and the economic scenarios and stress-tests. Someone asking the model to indicate how CDO prices will act in the future, for example, must first offer a guess about what will happen to the underlying credit curves, to not only the economic underpinnings, but to the market's risk-aversion, risk appetite, and to risk-signals that can include anything from currency exchange rates and inflation and LIBOR rates to corporate profits and length and depth of credit and economic cycles to arrive at not only defaults but also net recoveries! Perception of the riskiness of individual bonds affect shot-term investors wholly differently from long term investors and differently again in terms of the type balance sheet profit statements quarter by quarter or over several years. Trouble awaits those who blindly trust the model's output instead of recognising the differentiating impacts as well as questions about whether they are making a bet based only on what they told the model to calculate or on what else can happen? Mr. Li worried in 2005 that "very few people understand the essence of the model!"
Consider the trade that trips up hedge funds say, when selling insurance on the riskiest slice of a synthetic CDO and looking to the model for a way to hedge the danger that default risk will increase. Using the model, investors may calculate they can offset that danger by buying a double dose of insurance on a more conservative slice. That looks like a great deal. When everyone does it the insurers look insolvent and the pack of cards, the whole asset class, liable to total collapse. If selling protection on the riskiest slice and agreeing to pay as much as $10 million to cover the pool's first default losses, say, the protection-selling investor would collect a $3.5m upfront payment and an additional $500,000 yearly. Hedging the risk would pre-credit crisis cost that investor a mere $415,000 annually to buy protection on a $20 million conservative piece. Today, the cost can be $3-7m or in fact be impossible to buy! Pre-credit crunch the model's hedge assumed only one possible future: prices of all credit-default swaps in the synthetic CDO move in sync. They don't. This has been clear, or should have been for years! When back May 5, 2005, when the outlook for most bond issues stayed steady, GM and Ford Motor Co., both were downgraded by S&P to below investment-grade. That event caused a jump in the price of protection on GM and Ford bonds. Within two weeks, the premium payment on the riskiest slice of a CDO containing them, the slice most exposed to defaults, leapt to $6.5m upfront. The r result: An investor who had sold protection on the riskiest slice for $3.5 million had a paper loss of nearly $3 million. That's because if the investor wanted to get out of the investment, he would have to buy a like amount of insurance from somebody else for $6.5 million, or $3 million more than he was getting.
The simultaneous investment in the conservative slice proved an inadequate hedge. Because only GM and Ford saw their default risk soar, not the rest of the bond world, the pricing of the more conservative slices of the pool didn't rise nearly as much as the riskiest slice. So there wasn't much of an offsetting profit to be made there by reselling that insurance. Also, this wasn't really the fault of the model, which was designed mainly to price the tranches, not to make predictions. The model assumed the various credit curves would move in sync. and allowed investors to adjust this assumption, an option that some ignored. Because numerous hedge funds made the same credit-derivatives bet, the turmoil they faced spilled over into stock and bond markets. Many investors worried hedge funds might have to dump assets to cover their losses, so they sold, too. Some hedge funds lost a separate bet that relied on GM's bond and stock prices moving in tandem; but went wrong when GM shares rallied when Kirk Kerkorian said he would bid for GM shares.
Writing to investors, fund manager Jean-Michel Hannoun called the market reaction to the GM and Ford credit downgrades too improbable an event for the hedge fund's risk model to capture.
Now, take that example and extrapolate it say 200-fold and we begin to approach the current crisis. Following these events, academics and central bank researchers all started writing paper on systemic risk and the credit default and off-balance sheet securitization markets, and double-default risk, all got extra attention under Basel II. But, BIS in 2005 said, "the events of spring 2005 might not be a true reflection of how these markets would function under stress." Stanford's Prof. Duffie disagreed, "The question is, has the market adopted the model wholesale in a way that has overreached its appropriate use? I think it has." David Li said, "it's not the perfect model. (But) There's not a better one yet." And that more or less is how matters were left until the full earthquake of the credit crunch hit!

DAVID X. LI - Enter The Dragon

2009-03-05T06:35:00.000-08:00

Enter Li, a star mathematician who grew up in Mao's Red Guards-led Cultural Revolution in rural China in the 1960s. He excelled in school and eventually got a master's degree in economics from Nankai University before leaving the country to get an MBA from Laval University in Quebec. That was followed by two more degrees: a master's in actuarial science and a PhD in statistics, both from Ontario's University of Waterloo. In 1997 he landed at Canadian Imperial Bank of Commerce, where his financial career began in earnest; later, via JPMorgan Chase, he moved to Barclays Capital and by 2004 was charged with rebuilding its quantitative analytics team.
Li's trajectory is typical of the quant era, which began in the mid-1980s. Academia could never compete with the enormous salaries that banks and hedge funds were offering. At the same time, legions of math and physics PhDs were required to create, price, and arbitrage Wall Street's ever more complex investment structures.
In 2000, while working at JPMorgan Chase, Li published a paper in The Journal of Fixed Income titled "On Default Correlation: A Copula Function Approach." (In statistics, a copula is used to couple the behavior of two or more variables.) Using some relatively simple math—by Wall Street standards, anyway—Li came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps.
David X. Li - Illustration: David A. Johnson - If you're an investor, you have a choice these days: You can either lend directly to borrowers or sell investors credit default swaps, insurance against those same borrowers defaulting. Either way, you get a regular income stream—interest payments or insurance payments—and either way, if the borrower defaults, you lose a lot of money. The returns on both strategies are nearly identical, but because an unlimited number of credit default swaps can be sold against each borrower, the supply of swaps isn't constrained the way the supply of bonds is, so the CDS market managed to grow extremely rapidly. Though credit default swaps were relatively new when Li's paper came out, they soon became a bigger and more liquid market than the bonds on which they were based.
When the price of a credit default swap goes up, that indicates that default risk has risen. Li's breakthrough was that instead of waiting to assemble enough historical data about actual defaults, which are rare in the real world, he used historical prices from the CDS market. It's hard to build a historical model to predict Alice's or Britney's behavior, but anybody could see whether the price of credit default swaps on Britney tended to move in the same direction as that on Alice. If it did, then there was a strong correlation between Alice's and Britney's default risks, as priced by the market. Li wrote a model that used price rather than real-world default data as a shortcut (making an implicit assumption that financial markets in general, and CDS markets in particular, can price default risk correctly).
It was a brilliant simplification of an intractable problem. And Li didn't just radically dumb down the difficulty of working out correlations; he decided not to even bother trying to map and calculate all the nearly infinite relationships between the various loans that made up a pool. What happens when the number of pool members increases or when you mix negative correlations with positive ones? Never mind all that, he said. The only thing that matters is the final correlation number—one clean, simple, all-sufficient figure that sums up everything. The effect on the securitization market was electric. Armed with Li's formula, Wall Street's quants saw a new world of possibilities. And the first thing they did was start creating a huge number of brand-new triple-A securities. Using Li's copula approach meant that ratings agencies like Moody's—or anybody wanting to model the risk of a tranche—no longer needed to puzzle over the underlying securities. All they needed was that correlation number, and out would come a rating telling them how safe or risky the tranche was.
As a result, just about anything could be bundled and turned into a triple-A bond—corporate bonds, bank loans, mortgage-backed securities, whatever you liked. The consequent pools were often known as collateralized debt obligations, or CDOs. You could tranche that pool and create a triple-A security even if none of the components were themselves triple-A. You could even take lower-rated tranches of other CDOs, put them in a pool, and tranche them—an instrument known as a CDO-squared, which at that point was so far removed from any actual underlying bond or loan or mortgage that no one really had a clue what it included. But it didn't matter. All you needed was Li's copula function.
The CDS and CDO markets grew together, feeding on each other. At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion. The CDO market, which stood at $275 billion in 2000, grew to $4.7 trillion by 2006. At the heart of it all was Li's formula. When you talk to market participants, they use words like beautiful, simple, and, most commonly, tractable. It could be applied anywhere, for anything, and was quickly adopted not only by banks packaging new bonds but also by traders and hedge funds dreaming up complex trades between those bonds. "The corporate CDO world relied almost exclusively on this copula-based correlation model," says Darrell Duffie, a Stanford University finance professor who served on Moody's Academic Advisory Research Committee. The Gaussian copula soon became such a universally accepted part of the world's financial vocabulary that brokers started quoting prices for bond tranches based on their correlations. "Correlation trading has spread through the psyche of the financial markets like a highly infectious thought virus," wrote derivatives guru Janet Tavakoli in 2006.
The damage was foreseeable and, in fact, foreseen. In 1998, before Li had even invented his copula function, Paul Wilmott wrote that "the correlations between financial quantities are notoriously unstable." Wilmott, a quantitative-finance consultant and lecturer, argued that no theory should be built on such unpredictable parameters. And he wasn't alone. During the boom years, everybody could reel off reasons why the Gaussian copula function wasn't perfect. Li's approach made no allowance for unpredictability: It assumed that correlation was a constant rather than something mercurial. Investment banks would regularly phone Stanford's Duffie and ask him to come in and talk to them about exactly what Li's copula was. Every time, he would warn them that it was not suitable for use in risk management or valuation.
In hindsight, ignoring those warnings looks foolhardy. But at the time, it was easy. Banks dismissed them, partly because the managers empowered to apply the brakes didn't understand the arguments between various arms of the quant universe. Besides, they were making too much money to stop.
In finance, you can never reduce risk outright; you can only try to set up a market in which people who don't want risk sell it to those who do. But in the CDO market, people used the Gaussian copula model to convince themselves they didn't have any risk at all, when in fact they just didn't have any risk 99 percent of the time. The other 1 percent of the time they blew up. Those explosions may have been rare, but they could destroy all previous gains, and then some.
Li's copula function was used to price hundreds of billions of dollars' worth of CDOs filled with mortgages. And because the copula function used CDS prices to calculate correlation, it was forced to confine itself to looking at the period of time when those credit default swaps had been in existence: less than a decade, a period when house prices soared. Naturally, default correlations were very low in those years. But when the mortgage boom ended abruptly and home values started falling across the country, correlations soared.
Bankers securitizing mortgages knew that their models were highly sensitive to house-price appreciation. If it ever turned negative on a national scale, a lot of bonds that had been rated triple-A, or risk-free, by copula-powered computer models would blow up. But no one was willing to stop the creation of CDOs, and the big investment banks happily kept on building more, drawing their correlation data from a period when real estate only went up. "Everyone was pinning their hopes on house prices continuing to rise," says Kai Gilkes of the credit research firm CreditSights, who spent 10 years working at ratings agencies. "When they stopped rising, pretty much everyone was caught on the wrong side, because the sensitivity to house prices was huge. And there was just no getting around it. Why didn't rating agencies build in some cushion for this sensitivity to a house-price-depreciation scenario? Because if they had, they would have never rated a single mortgage-backed CDO."
Bankers should have noted that very small changes in their underlying assumptions could result in very large changes in the correlation number. They also should have noticed that the results they were seeing were much less volatile than they should have been—which implied that the risk was being moved elsewhere. Where had the risk gone? They didn't know, or didn't ask. One reason was that the outputs came from "black box" computer models and were hard to subject to a commonsense smell test. Another was that the quants, who should have been more aware of the copula's weaknesses, weren't the ones making the big asset-allocation decisions. Their managers, who made the actual calls, lacked the math skills to understand what the models were doing or how they worked. They could, however, understand something as simple as a single correlation number. That was the problem.
"The relationship between two assets can never be captured by a single scalar quantity," Wilmott says. For instance, consider the share prices of two sneaker manufacturers: When the market for sneakers is growing, both companies do well and the correlation between them is high. But when one company gets a lot of celebrity endorsements and starts stealing market share from the other, the stock prices diverge and the correlation between them turns negative. And when the nation morphs into a land of flip-flop-wearing couch potatoes, both companies decline and the correlation becomes positive again. It's impossible to sum up such a history in one correlation number, but CDOs were invariably sold on the premise that correlation was more of a constant than a variable.
No one knew all of this better than David X. Li: "Very few people understand the essence of the model," he told The Wall Street Journal way back in fall 2005. "Li can't be blamed," says Gilkes of CreditSights. After all, he just invented the model. Instead, we should blame the bankers who misinterpreted it. And even then, the real danger was created not because any given trader adopted it but because every trader did. In financial markets, everybody doing the same thing is the classic recipe for a bubble and inevitable bust.
Nassim Nicholas Taleb, hedge fund manager and author of The Black Swan, is particularly harsh when it comes to the copula. "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked," he says. "Co-association between securities is not measurable using correlation," because past history can never prepare you for that one day when everything goes south. "Anything that relies on correlation is charlatanism."
Li has been notably absent from the current debate over the causes of the crash. In fact, he is no longer even in the US. Last year, he moved to Beijing to head up the risk-management department of China International Capital Corporation. In a recent conversation, he seemed reluctant to discuss his paper and said he couldn't talk without permission from the PR department. In response to a subsequent request, CICC's press office sent an email saying that Li was no longer doing the kind of work he did in his previous job and, therefore, would not be speaking to the media.
In the world of finance, too many quants see only the numbers before them and forget about the concrete reality the figures are supposed to represent. They think they can model just a few years' worth of data and come up with probabilities for things that may happen only once every 10,000 years. Then people invest on the basis of those probabilities, without stopping to wonder whether the numbers make any sense at all. As Li himself said of his own model: "The most dangerous part is when people believe everything coming out of it."
from: article by Felix Salmon (felix@felixsalmon.com) writes the Market Movers financial blog at Portfolio.com.

THE YOU COULDN'T INVENT IT SCANDAL - BUT DAVID LI DID

2009-03-04T10:59:00.000-08:00

- taken from WIRED magazine.
David Li's formula, known as a Gaussian copula function was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored. In 2000, while working at JPMorgan Chase, Li .came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps. When the price of a credit default swap goes up, that indicates that default risk has risen. Li's breakthrough was that instead of waiting to assemble enough historical data about actual defaults, which are rare in the real world, he used historical prices from the CDS market/ Li wrote a model that used price rather than real-world default data as a shortcut (making an implicit assumption that financial markets in general, and CDS markets in particular, can price default risk correctly).
The effect on the securitization market was electric. Armed with Li's formula, Wall Street's quants [i.e. math wizards] saw a new world of possibilities. And the first thing they did was start creating a huge number of brand-new triple-A securities. Using Li's copula approach meant that ratings agencies like Moody's—or anybody wanting to model the risk of a tranche—no longer needed to puzzle over the underlying securities. All they needed was that correlation number, and out would come a rating telling them how safe or risky the tranche was.
As a result, just about anything could be bundled and turned into a triple-A bond—corporate bonds, bank loans, mortgage-backed securities, whatever you liked. The consequent pools were often known as collateralized debt obligations, or CDOs. You could tranche that pool and create a triple-A security even if none of the components were themselves triple-A. You could even take lower-rated tranches of other CDOs, put them in a pool, and tranche them—an instrument known as a CDO-squared, which at that point was so far removed from any actual underlying bond or loan or mortgage that no one really had a clue what it included. But it didn't matter. All you needed was Li's copula function.
The CDS and CDO markets grew together, feeding on each other. At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion *reduced by net clearing today to just under $50 trillions). The CDO market, which stood at $275 billion in 2000, grew to $4.7 trillion by 2006.
At the heart of it all was Li's formula. When you talk to market participants, they use words like beautiful, simple, and, most commonly, tractable. It could be applied anywhere, for anything, and was quickly adopted not only by banks packaging new bonds but also by traders and hedge funds dreaming up complex trades between those bonds. "The corporate CDO world relied almost exclusively on this copula-based correlation model," says Darrell Duffie, a Stanford University finance professor who served on Moody's Academic Advisory Research Committee. The Gaussian copula soon became such a universally accepted part of the world's financial vocabulary that brokers started quoting prices for bond tranches based on their correlations. "Correlation trading has spread through the psyche of the financial markets like a highly infectious thought virus," wrote derivatives guru Janet Tavakoli in 2006.
David X. Li's Gaussian copula function as first published in 2000. Investors exploited it as a quick—and fatally flawed—way to assess risk. A shorter version appears on this month's cover of Wired. Probability Pr
Specifically, this is a joint default probability—the likelihood that any two members of the pool (A and B) will both default. It's what investors are looking for, and the rest of the formula provides the answer.
Survival times [T]
The amount of time between now and when A and B can be expected to default. Li took the idea from a concept in actuarial science that charts what happens to someone's life expectancy when their spouse dies.
Equality the = sign
A dangerously precise concept, since it leaves no room for error. Clean equations help both quants and their managers forget that the real world contains a surprising amount of uncertainty, fuzziness, and precariousness.
Copula the copula symbol bits
This couples (hence the Latinate term copula) the individual probabilities associated with A and B to come up with a single number. Errors here massively increase the risk of the whole equation blowing up.
Distribution functions the ((F))
The probabilities of how long A and B are likely to survive. Since these are not certainties, they can be dangerous: Small miscalculations may leave you facing much more risk than the formula indicates.
Gamma the Y symbol
The all-powerful correlation parameter, which reduces correlation to a single constant—something that should be highly improbable, if not impossible. This is the magic number that made Li's copula function irresistible.
Li's copula function was used to price hundreds of billions of dollars' worth of CDOs filled with mortgages. And because the copula function used CDS prices to calculate correlation, it was forced to confine itself to looking at the period of time when those credit default swaps had been in existence: less than a decade, a period when house prices soared and so risk priced only a one-way market - UP.

THAT GEITHNER SPEECH CREDIT CRUNCHED!

2009-02-15T03:48:00.000-08:00

MY BONUS IS YOUR BONUS TOO!

2009-02-13T05:28:00.000-08:00

In line with public anger, Government and regulator sentiments, I wish to advise all my clients that I voluntarily accept a zero bonus remuneration cap for 2009 and 2010. Contractually binding arrangements with my various service companies, onshore and offshore, and unearned income streams from my various % of our portfolios remain as before. New York State Comptroller Thomas P. DiNapoli estimates that the US securities industry granted its employees $18.4 billions in bonuses in 2008 – a revelation that President Barack Obama characterizes as “shameful". I agree with him, this is very poor show. However, actual payout is much higher than this surely? $18.4 billion is only the cash portion of the bonus payouts and only accounted for the money paid to securities-industry employees who worked in NYC. Bonuses paid to such as myself working outside the city aren’t included. The Comptroller’s estimates don't include stock options not yet exercised, worth about another 25-100% of the cash bonus. Wall Street’s appetites for high rewards are said to have precipitated the banking-credit crisis, requiring taxpayers to pay our bills. and I don't charge any fees for photo opportunities or other busines smeetings and parties in the city. In future my bonuses will come from advising how taxpayers too may enjoy financial profits by packaging and selling assets at mouth-watering discounts to the Treasury and Federal Reserve, and this is what I've been telling little and big investor people at every opportunity. Currently, it is supposed that those same taxpayers are being asked to finance Wall Street’s bonus payouts, which were actually a proximate cause of the crisis. Not so. Tax liabilities for buying toxic bank assets generating substantial coupon may be deferred over a 20 year period! In fact, we are busy collecting tax liabilities right now, packaging these up and selling them at private auction. Thus, just as we distributed risk, we are now distributing the bonus rewards too and I feel sure that my remuneration (performance-related) will be commiserate. Life is a matter of incentives whether for actions that led to the near-collapse of the U.S. banking system or better for actions that lead to its miraculous recovery. This is just bio-economics, the fundamental greed, deceit and indifference of Adam Smith's "invisible hand" lending another "invisible hand" to redeeming the travesty of a mockery of a sham, shameful, irresponsible, hubris and so on being turned to greater advantage for all. Understanding the social dimension of the compensation equation requires a qualitative look at more than just the numbers. And for this our latest algorithmic models and techniques are the best in the business.
To all my employees I say, yes, proxy season is fast-approaching: the time of year when public companies – ahead of AGMs – send out proxy statements for shareholder resolutions and senior-exec compensation, but not in the same post please as interim trading statements, and when my institutional poker school friends collect your proxy votes to back each of my Board resolutions for the forseeable future measured by proxy asymptotic single factor economic risk indicators, red, amber, or green proxy-wise. The media paparazzi will attempt to photograph you by your new pool or at downtown champagne parties, on yachts in the Med and so on - it is the start of the shooting season on bonus execs, long eye-watering stories about huge payouts in cash, shares or other trinkets (all merely relative of course), quite forgetting that we pay tax at source, unless offshore (or non-cash in kind as in my companies' bonus barter timeshare system), or postponed bonuses and grants of stock numbered options under treasury SNOUT and structured complex original option plans, SCOOP.
This year, however, due to the ongoing financial restructuring crisis (plight for some, opportunity for others), exec-pay has become elevated to a most heightened emotional level (including by private plane, helicopter, boat, tourist property, clubs, restaurants, private schools, charities and luxury goods companies). Some firms taking government bail money have paid big bonuses (what in our group we now call arrangement & legal fees, independent valuation studies, due diligence costs etc. without attracting the ire of Federal legislators and the U.S. President's administration). Just so my employees understand why we're capping cash at $0.5m each, yesterday President Obama announced a salary cap of $500,000 for top execs (in firms participating in federal bailout programs) as an expression of fairness and “basic common sense.” Note: For 10 years, the NY State Comptroller’s office estimated bonuses paid to NYC-based securities industry employees. Last year's $18.4 bn is a 44% down from the $32.9 bn in 2007. But, that ain’t quite so steep as our Wall Street friends fear. We cut payrolls by 19,200, roughly 10.2% off the 2007 level of 187,800, so today's average bonus of $112,000 is now dispersed over fewer, a drop of only 36% (ave. cash bonus in 2007 was $175,186). Of course, not all of you gets a bonus and some folks get only small ones for now. Our clerks making $35,000 a year gross ain't getting $112,000, nosirree; but if you get to be a trader on say $150,000 gross, hey there's $2 m in your bonus pot (before tax) and you sure better be worth it! This here is a profit-driven industry, what goes to our traders comes straight outta my and my partners' share, and our shareholders and bondholders and the IRS and so on too of course! It’s important to remember all that, that while all are paid enough for the basics of living and commuting, bonuses are what you really work for as bankers, stock traders, money brokers and bond managers. To those of you who've been fired and not rehired, y'all can kiss that goodbye. Top salaries hereabouts are $100,000 to $750,000, but most are in the low-six-figure column of our IRS spreadsheet. In my case I am not salaried, of course, therefore all such restrictions and equations do not apply.
Our peer-group comparisons: end of last year, top guys at Goldmans decided to forgo any cash, stock or options bonuses for 2008, “the right thing to do” and I applaud their reinvestment of these for the future when valuations are near bottom. The top execs make do with $600,000 salaries aside from 'unearned incomes'. As for lower employees, they get a bonus pool of $2.6bn. But none of the $25bn of TARP money GS received will go to bonuses directly, not now, all sensibly reinvested. There is a nobility about forgoing bonus compensation on top of a $0.6m salary before tax. To understand the nobility of this, in 2007 CEO Lloyd C. Blankfein was worth $68.5m; co-presidents Jon Winkelried and Gary D. Cohn $67.5m; and David A. Viniar, CFO, $57.5m, all before tax. Politics: President Obama calls the $18.4 bn bonus pool “shameful,” U.S. Sen. Claire McCaskill, D-MO (pictured above in the pink), says that we "[just] don’t get it. These people are idiots.” I beg to differ here. This is a great time to be investing and not focusing on current income, not when returns to cash are paltry. Such funds are far better left in the business medium term to earn bigger returns later. McCaskill cites that execs at 116 banks that got government funds were paid an average of $2.6m in bonuses and 700 at Merrils got $1m or more. How can she say we're all idiots to be doing so well?
Responsible budgeting: Citigroup Inc. has reconsidered a $50m corporate jet in the context of $45bn Federal funds plus $300bn in government insurance received against losses on toxics. Obviously $50m is chump change in bigger picture. Citi cancelled delivery of the jet, because of pressure from U.S. Treasury Dept. What business is it of Treasury to worry about minor PR like this? Anyways, lease-back is an option in order not to damage the aerospace manufacturing sector at this critical time, and to help Citi out we may do the deal for them as a soft commission fee for which we'll chuck in our OBAMA remuneration risk metrics system for free.
McCaskill is vocalizing her voters' anger and has sponsored a bill called the Cap Executive Officer Pay Act CEOPA, so that any bail money recipients are capped at $400k, 25% less than President Obama is willing to grant. She picked $400k because that’s the salary paid to the President Obama, or 8 times median U.S. household income – which may not seem too bad, except for my pal Goldman’s Blankfein . who made that every 2 days back in the good days. A fuller accounting might include office costs, travel and other incidentals, and then I guess the Obama ratio measure would go up, like a whole lot. Sen. McCaskill doesn’t want to take away our toys or the 'punchbowl' entirely; she says once taxpayers get back what we owe them, we are free to pay whatever. The US Treasury’s TARP requires that senior-exec compensation is subject to “clawbacks” if compensation is based on inaccurate algorithms, where our new product comes in bigtime, the OBAMA (Opaque Bonus Assessment Management Algorithm). There's no color bar here as my pal Stan will confirm. For all our execs who artfully insist on severances and golden parachute contracts after bailing out or being pushed out of whatever they helped wreck, there’s no such provision envisaged in our proxies and next published accounts. I'm mindful of the plight of nice guy pal Merrill Lynch CEO “Stan” O’Neal, who got retired after announcing losses of $8bn (later revised to over $27bn, by the end of '08). He had to take a pay deal of $161m. But I told him, "Stan, with out OBAMA calc you can get a Bank of America pension fund bonus due on the tax saving over the 20 year period this loss is recoverable from the IRS. This shows just how effective our OBAMA bonus culture is when re-structured for "long term sustainable performance" measures.
My other close friends such as Citigroup boss Chuck Prince, who left with a $38m so-called “bonus” after announcing $billions in losses and steering the bank close to but not into near technical-insolvency, he took our advice in at least highlighting $500bn of book value potential sales when we showed how this may now be written down by say $150bn and become a valuable long term profitable tax liability vehicle subject to a series of complex related business programs of sell-offs and rehirings financed out of a 20 year MTN program. Or too, Martin Sullivan, former CEO of AIG, a great guy with a massive pool in his basement I paid for, when AIG won $85bn in cash and another $45bn in insurance backstops. For this he got $39.6m in his last 3 years and so this needed topping up using our OBAMA model with a useful additional $47m, that my boys figured out to be $15m severance, $4m bonus proportionate to the days he actually worked (at the office), plus stock and long-term cash worth about $28m. It is people like us who are the makers of money, the 'invisible hand' that according to the Scottish Saint of the matter of how to make it, Adam Smith, indirectly benefits everyone. This is something the cartoonists will never understand and of course I have to laugh too. In the final analysis, as my friends ask themselves fearlessly, are we worth what we are paid. Sure. Well, clearly given the risk/reward scale at which we take big decisions, would it be safe to pay us any less? And we know that now we are going to be making money for taxpayers too and that means bigger benefits all round! As I said at the last Algonquin Club gettogether “We want the smartest folks running these firms and in order to get them you have to compensate them or they will go elsewhere, maybe to the Caribbean. And don't forget we must be damn sure smart as new paint to have gotten that much paid to us, anyways?” Some people think, small people, that now their time has come to make it in the big leagues! I say little league yes, world series never! America should always be diligent in resisting letting free markets have small people in charge, domestically or internationally, and compensation should not be regulated by any government ratios, otherwise good folk will believe it's ok to work only for the state instead of for themselves? There are limits to compensation and these could be in the same ratio as it is possible to leverage shareholders’ balance sheets and the systemic risks that threaten our planet that only the biggest people should be entrusted with. There were no regulators capable of shepherding the global system. There are no shareholders able to take down richly rewarded directors because that's what shareholders aspire to too, so don't kid yourselves that greed ain't good business sense. I expect to return from my Davos meetings to Wall Street, via Long Island, Miami, Bay Street, and Grand Cayman once the Easter holidaymakers start over-crowding the slopes at Val d'Isere, Wengen and Gstaad where I am always in touch with all of you via my secretary's Blackberry.

GREAT FIRE - TOO CONVENIENT!

2008-12-12T01:09:00.000-08:00

Economic and financial recovery is like the film Restoration (1995) from the book by Rose Tremain has drama just like our present recession. The story begins with young doctor, Robert Merivel (Robert Downey), in service of King Charles II (Sam Neill) after saving the King's spaniel. Merivel enjoys a life of hubris and careless pleasure at court, until the King orders Merivel to wed Celia, the King's mistress, basically to get the assets off balance sheet and fool other mistresses. The film opened as world bond markets went into meltdown. At the pre-screenings, the test audiences (Califormian muesli types) the written comments complained that The Great Fire of London seemed like an all too convenient plot device for resolving the story. Harv' Weinstein, a genius producer, furiously dipping into his jelly babies and diet cokes, foresaw a solution and this is why the final film is the first to open with a credits crunching sex scene (that was shot and edited by my brother Laurence - a brilliant cinematographer by the way).
What makes me think of this on the day of the HBOS shareholders' general meeting and vote on the Lloyds TSB takeover (a vote that looks like a totally foregone conclusion) is that I just hope they too have the insight to say hang on, something's just too convenient here, we're being tricked into selling out far too cheap!? The answer stands or falls on how unavoidably and all-destructive the Great Fire or Credit Crunch recession really is for these banks?
This morning, I also get an insightful email from Melvyn Bragg about the Great Fire: "Here are some observations and excerpts from the two great London diarists of the time, Samuel Pepys and John Evelyn. It seemed that people looked first and foremost to saving their own goods and getting out of the path of the flames, rather than considering what might be the best way to act in order to stop the fire outright. Pepys described in his diary entry [a dossier by a Government official that remained secret for 200 years] on 2nd September how he observed “Everybody endeavouring to remove their goods, and flinging into the river or bringing them into lighters that lay off; poor people staying in their houses as long as till the very fire touched them, and then running into boats, or clambering from one pair of stairs by the water-side to another…Having staid, and in an hour's time seen the fire rage every way, and nobody, to my sight, endeavouring to quench it, but to remove their goods, and leave all to the fire…” Pepys described the voracity of the fire in great detail and wrote how,as he walked along with his wife “all over the Thames, with one's face in the wind, you were almost burned with a shower of firedrops. This is very true; so as houses were burned by these drops and flakes of fire, three or four, nay, five or six houses, one from another. When we could endure no more upon the water; we to a little ale-house on the Bankside, over against the Three Cranes, and there staid till it
was dark almost, and saw the fire grow; and, as it grew darker, appeared more and more, and in corners and upon steeples, and between churches and houses, as far as we could see up the hill of the City, in a most horrid malicious bloody flame, not like the fine flame of an ordinary fire…We staid till, it being darkish, we saw the
fire as only one entire arch of fire from this to the other side of the bridge, and in a bow up the hill for an arch of above a mile long: it made me weep to see it. The churches, houses, and all on fire and flaming at once; and a horrid noise the flames made, and the cracking of houses at their ruins. So home with a sad heart…” (entry for 2nd September)
The diarist and town-planner, John Evelyn, described in his diary of 2nd September how the fire “continued all this night, which was as light as day for ten miles round, in a dreadful manner, I went on foot to the same place. The conflagration was so universal, and the people so astonished, that from the beginning they hardly stirred to quench it, so that there was nothing heard or seen but crying out and
lamentation, running about like distracted creatures, without attempting to save even their goods. It leapt after a prodigious manner from house to house, and street to street, at great distances one from the other. Here we saw the Thames covered with goods floating, all the barges and boats laden with what some had time and courage to save. And the fields for many miles were strewn with movables of all sorts, and tents erecting to shelter both people and what goods they could get away. Oh, the miserable and calamitous spectacle! London was, but is no more!”
For London then read Edinburgh and Scotland today!

WHEN BANKS MERGE?

2008-12-09T23:28:00.000-08:00

The merger of Lloyds TSB and HBOS is at risk of becoming a nightmare for both banks at a time when there are nightmares a plenty in the markets and the economy. This is a time for J. Shumpeter's 'creative destruction' (see comment below). It will be two steps back for one step forward. Why?
Lloyds TSB expects to integrate HBOS and achieve 'synergies'. At the same time the whole of both banks have to be shrink-washed, assets run-down and a new economic capital model created as condition of redeeming the Government's 43+% shareholding. Lloyds is already planning what to writedown and sell-off including talking with potential buyers for this or that even before the deal is finally certain. HBOS has moved half a £billion of PFI assets off balance sheet and sold some non-banking holdings as well as Westpac Bank (for a fraction of its book value). In the merger process 20,000 jobs are expected to be cut. HBOS staff can expect to bear the brunt of this and they are all distinctly queasy, angry, and unhappy. What is the risk-value of merging with a distressed bank and uncooperative, or let's say less than enthusiastic, staff? Lloyds will use as its template how Royal Bank of Scotland integrated the operations and systems of NatWest a decade ago. That time the cost (external not internal) was somewhere in the region of £3 billions. Cost savings, called 'synergies', are expected to be worth £1.5bn a year. But it will take several years to get to that. HBOS's internal systems are probably much supperior to Lloyds, but Lloyds has the whip hand in this merger. Lloyds general ledger core accounting is reputedly a 30 year old model long past its replacement date. A 4 year old project to modernise financial reporting within the bank has been cancelled half way through? HBOS had problems in integrating with Halifax. But this was a merger of equals (financially) and much effort was expended to choose and keep the best, and anyway the two bamks had so many complementarities that integrating into a single contiguous system at all levels and across all business units was thankfully not worth doing.
Deloittes, the audit and consulting firm, emailed me recently about bank mergers to say, "...All those dreams of capturing synergies through higher revenues and lower costs may turn to dust if you don’t incorporate information technology (IT) into the integration process from start to finish. By failing to invite IT to the party, companies may overpay for an acquisition and suffer buyer’s remorse down the road. And once the transaction is completed, IT still has a crucial role to play in whether the expected synergies actually deliver on the promise of the deal. Here’s the bottom line: Integration without IT is no integration at all". Synergies, if narrowly cost-ratio determined, are illusory anyway in my extensive experience - they are demanded by stock market analysts as a fig-leaf wanting to be told the values-added of "why buy?", when the real why buy is simply for bigger market share. But, when two big players merge in markets where players trade directly with each other, the merger wipes out a large slice of the markets' in depth liquidity. And this also happens in domestic traditional banking. A lot of assets are borrowings by households and businesses merely to re-cycle other loans with other lenders. So when LTSB and HBOS merge they make UK domestic banking volume smaller. The 'velocity of capital' in the UK economy will fall significantly, and do so when it is alreday falling too much anyway (credit crunch + recession). This is not good for anyone. Mergers in such conditions will find that expected gains prove largely illusory, a mirage in a fast desertifying landscape.
M&A projects all too readily assume integration is worthwhile and forgets that one or more company cultures (internal brand value, procedures & processes - very delicate) is destroyed and a new culture has to be created. This is why it is two steps back for one step forward. It is like taking two different very fine highly elaborate swiss watches, taking them to bits and trying to build a new watch with a mix of bits from both the originals. It doesn't work. So what happens - a whole new bank infrastructure and IT systems need to be bought in, tailored, legacy data populated into new gone live systems, tested and tested again many times, rolled out operationally, training and more training, bug fixing and more bugs - an endless cycle of improvements and replacement that should take normally no more than 18 months but will take a full 5 years, by which time half of everything is outdated and needs replacing again!
Far better is to maintain the banks as separately operating entities under a holding company and only judiciously integrate beginning at the top and moving down layer by layer and business unit by unit only as and when business cases are convincing and change necessary. Cultural changes take time. Banks are not standard machines; they are people businesses with quirky and highly-elaborated unique systems that are very complicated to intergrate. There is no way that everything can be changed at the same time. This would overwhelm management resources as well as intellectual and technical skills available to the bank and available in the marketplace. Some people use the analogy of merging two railways with different gauge size of tracks. It is not like that. My advice: forget root and branch integration synergies and stick to what really matters especially at this time which are economic risk management and financial risk accounting.

MAG v. Secretary of State (Lloyds TSB takeover of HBOS)

2008-12-04T09:33:00.000-08:00

In this case before the Competition Appeal Tribunal Merger Action Group (www.mergeractiongroup.org.uk) challenges the Secretary of State's assertion (a Government discretionary decision, 18 & 31 September) that the takeover of HBoS by LTSB not be referred to the Competition Commission (CC) because the public interest of Financial Stability is greater than competition issues. In effect, Government (and the two banks) either know and accept that competition in UK domestic banking will suffer and/or they have good grounds for believing this merger is so urgently vital in the interest of the stability of the UK financial system that there is no time for a referral, and/or the Government has good grounds for believing this merger would not be against the public interest to have competitiveness among UK banks maintained.
The two banks will enjoy roughly 30-40% of UK domestic banking, which is twice the level considered a 'dominant' position. To be in a position of dominance, a business must have the ability to act independently of its customers, competitors and consumers. Establishing if a company is dominant requires a complex assessment of a number of elements but, as a general rule, if a business has a 50% market share there is a presumption that it is dominant. However, dominance has been found to exist where market share is as low as 40% and even 15%. To be a major player in a market only requires 5% market share. Under EU law, Article 82 requires dominance in a substantial part of the European Union, but there is no requirement under Chapter II that a dominant position must be held in a substantial part of the UK, meaning that, in theory at least, dominance could be considered to exist in a fairly small area of the UK e.g. Scotland or North of England or even a sub-region.
Having a dominant position does not in itself breach competition law. It is the abuse of that position (or the potential for likely abuse in the absence of safeguards) that is prohibited. Examples of behaviour that could amount to an abuse by a business of its dominant position include:
- imposing unfair trading terms, such as exclusivity e.g. in factoring by banks;
- excessive, predatory or discriminatory pricing e.g. in mortgages;
- refusal to supply or provide access to essential facilities e.g. SME overdrafts;
- tying e.g. stipulating a customer for one loan product must also purchase all or some of a second product such as insurance.
In this context it is a powerful statement by the OFT that competition will be damaged according to the conclusions of its report, which is why MAG wants the merger referred to the CC. Exceptions may be sought if some other larger benefit of the merger is sufficient to substantially outweigh a loss of market competitiveness. And this benefit should be long term, not just a short term benefit! But, as Sir Ian Burt and Sir George Mathewson reasonably stated (two senior bankers who should know intimately about these things) in their published letter, financial market conditions have changed since 18 September such that financial stability should not be an issue following the Government's intervention (£56bn) to supplement the reserve capital of UK banks of systemic importance. Therefore, they say that the benefit of financial sector stability is no longer served by this merger and no longer relevent as a reason for not referring the merger to the CC. The Government based its decision on the views of the FSA, which MAG asserts are irrelevent and/or has failed to respect section 46(2) of the Competition Act (1998) and is seeking an order quashing the Secretary of State's decision pursuant to the power conferred by section 120(5) of the Act.
Clearly, stability is a short term concern while market competitiveness is a longer term concern. But, the latter appears to be of substantially less importance to Government (deciding on behalf of the general public interest). The Government's reliance on advice from the FSA is odd insofar as it is the Bank of England, not the FSA, that is responsible for UK financial sector stability. The FSA is responsible for UK financial sector resilience. If the Government's decision had been based on 'resilience' not 'stability' its argument might appear more valid. There is absolutely nothing in the Bank of England's many reports, especially in any of its Stability Reports/Reviews that indicate bank mergers as a factor of interest or concern in this context? The FSA states on its website merely, "The announcement of the proposed merger with Lloyds TSB is a welcome move as it is likely to enhance stability within financial markets and improve confidence among customers and investors in the UK financial sector." There is no basis offered for this claim? The FSA adds that "The merger will be subject to shareholder approval and approval by the FSA, OFT and some overseas regulators." But, the OFT does not approve. On 24th October it recommended referring the merger to the CC, advice overriden at the discretion of the Secretary of State on 31st October. The report, which the OFT submitted to the Secretary of State on 24 October 2008, contains the following advice and decisions: there is a realistic prospect that the anticipated merger will result in a substantial lessening of competition in relation to personal current accounts (PCAs), banking services for small and medium sized enterprises (SMEs) and mortgages . The OFT's concerns on PCAs and mortgages are at the national (Great Britain) level, while its concerns on SME banking services are focused on Scotland. In addition, the OFT cannot exclude competition concerns arising at the local level in relation to PCAs and SME banking services. No further competition concerns are considered to arise in relation to the other identified overlaps between the parties in retail banking (savings, wealth management, personal loans, credit cards and pensions), corporate banking (banking services to large corporations, asset finance/fleet car hire) and insurance (PPI, life, general), and in the absence of any offer of remedies from the parties, it would not be appropriate to deal with the competition concerns arising from the merger by way of undertakings in lieu of reference to the Competition Commission. The OFT finds that the combined market share of HBoS & LTSB would be 30-40%! The challenge by the Merger Action Group (MAG) should be allowed to challenge the basis for the Government's belief i.e. whatever technical advice it received whereby it considered it could anticipate or make unnecessary a full enquiry by the CC. Information required from the two banks on this question are determined to be business-confidential and therefore can be delivered in summary only to MAG and the Tribunal?

NOTES
Details of Competition Appeal Tribunal procedures are at www.catribunal.org.uk
Merger Action Group (“the Applicant”), is an unincorporated association of persons and businesses established in Scotland, challenging a decision by the Secretary of State for Business, Enterprise & Regulatory Reform (contained in a document entitled “Decision by Lord Mandelson, the Secretary of State for Business) not to refer to the Competition Commission the merger between Lloyds TSB Group plc and HBOS plc under Section 45 of the Enterprise Act 2002 dated 31 October 2008” (“the Decision”). On 18 September 2008, the former Secretary of State, the Rt. Hon. John Hutton, issued a notice to the Office of Fair Trading (“OFT”) pursuant to section 42 of the Act (“the intervention notice”) stating that the stability
of the financial system in the United Kingdom ought to be specified as a public interest consideration in section 58 of the Act. The Secretary of State further stated that the stability of the UK financial system may be relevant to a consideration by the OFT of the merger situation arising out of the proposed merger
announced by Lloyds TSB Group plc (“Lloyds TSB”) and HBOS plc (“HBOS”) on 18 September 2008 (“the Merger”).
The intervention notice required the OFT to investigate and provide a report to the Secretary of State in accordance with section 44 of the Act within the period ending on 24 October 2008. The intervention notice also indicated that the Secretary of State would lay before Parliament for its approval an affirmative resolution to specify the new public interest consideration under section 58 of the Act. The relevant order completed Parliamentary scrutiny on 23 October 2008 and came into force on 24 October. The new public interest consideration has been added to the Act as section 58(2D). The OFT produced a report under section 44 of the Act dated 24 October 2008 entitled “Anticipated acquisition by Lloyds TSB plc of HBOS plc” (“the Report”)2. The Report includes decisions to the effect that it is or may be the case that arrangements are in progress or in contemplation which, if carried into
effect, will result in the creation of a relevant merger situation and the creation of that merger situation may be expected to result in a substantial lessening of competition (“SLC”) within a market or markets in the United Kingdom for goods or services, including personal current accounts, banking services to small and
medium enterprises and mortgages such that further inquiry by the Competition Commission (“the CC”) is warranted. The Report also provides that any relevant consumer benefits did not outweigh the SLC and it would not be appropriate to deal with the matter by way of undertakings under paragraph 3 of Schedule 7 to the Act. In deciding whether to make a reference to the CC under section 45 of the Act, the Secretary of State is required, under section 46(2) of the Act, to accept the decisions of the OFT as to the creation of a relevant merger situation which may be expected to result in SLC.The Decision states that the new public interest consideration contained in section 58(2D) of the Act, the stability of the UK financial system, is relevant to this case and that taking account only of the SLC and the public interest consideration, the Secretary of State believes that the creation of the relevant merger situation is not expected to operate against the public interest. The Secretary of State considers that the Merger will result in significant benefits to the public interest as it relates to ensuring the stability of the UK financial system and that these benefits outweigh the potential for the Merger to result in the anti-competitive outcomes identified by the OFT. The Decision (www.berr.gov.uk/files/file48745.pdf) states that no reference will be made to the CC (Competition Commission).

REFERENCES
1998 Competition Act - http://www.statutelaw.gov.uk/legResults.aspx?LegType=All+Primary&PageNumber=18&NavFrom=2&activeTextDocId=1455848
Case Name: Merger Action Group v Secretary of State for Business, Enterprise and Regulatory Reform
Case Number: 1107/4/10/08 Date Registered: 28 November 2008
Status: Summary of application published on 1 December 2008. By an Order of the President, made on 1 December 2008, the time for making a request for permission to intervene was abridged until 5.00pm on 2 December 2008. A case management conference took place on 3 December 2008 when HBOS plc and Lloyds TSB Group plc were granted permission to intervene. A hearing has been fixed for 12pm on 8 December 2008 with a time estimate of one day.
Tribunal: President - Sir Gerald Barling, Michael Blair QC, Professor Peter Grinyer
Documents: Order of the Tribunal (Confidentiality ring) - (17Kb) 03 December 2008
Order of the Tribunal - (17Kb) 03 December 2008 (http://www.catribunal.org.uk/documents/Order_proceedings_1107_Merger_031208.pdf)
Order of the President (abridging time for requests for permission to intervene) - (14Kb) 01 December 2008 (http://www.catribunal.org.uk/documents/Order_confidentiality_1107_Merger_031208.pdf)
Summary of application - (42Kb) 01 December 2008
http://www.catribunal.org.uk/documents/Summary_1107_MergerActionGroup_011208.pdf

TURKEYS ON THANKSGIVING

2008-11-27T10:30:00.000-08:00

AAA predicts 1.4% fewer Americans will travel 50 miles or more this Thanksgiving. If the prediction proves correct, it will be the first decline in Thanksgiving holiday travel since 2002. The biggest percentage decrease will be in airline travel, a possible 7.2% drop. One exception are only Americans without easy access to a full Turkey spread this Thanksgiving, yet who have travelled furthest - to dine on the Space Station where the inmates there are eating early tonight at the same time as I could see them from my farmhouse at 6:38pm at 12 degrees SSW just above the horizon and clearly visible to the naked eye on a cold stormy night in Scotland! The astronauts normally drink their meals through straws, but like hundreds of millions of Americans, the 7 Endeavour astronauts and 3 permanent crew members are enjoying at least something of a traditional Thanksgiving even if it is only liquidised turkey, cornbread stuffing and green beans. But, unlike earthbound families and colleagues, they're floating while feasting (through straws from plastic sachets, in the shuttle-international space station complex about 220 miles above my head - something of a metaphor for the earth's financial problems. The astronauts, at no expense spared, took delivery of a bathroom, kitchenette, two bedrooms, exercise equipment, but then experienced problems with the system for recycling liquid waste. It purifies sub-prime ingredients, urine, sweat and condensation into just about paletable drinking water. Flight controllers had considered returning the urine-recycling special purpose entity, a $154 million water system, back to Earth. But after 5 days of tinkering, astronauts got it working, and it's now churned out 7 litres of recycled urine & condensation. But NASA wants to test the samples and run the equipment in orbit for at least 3 months (classic 90 days overdue default test) before allowing anyone human to drink the stuff. Meanwhile, what are the turkeynomics back in the real world on Earth USA? Over 46 million USA turkeys get roasted this Thanksgiving! That's 675m pounds weight of turkey (or $1.7bn at $1 for frozen to $4 fresh per pound, up 9 cents or 2%) and full Thanksgiving dinners are costing US celebrants 5.5% more than last year,$44.61, up from $42.26. Many families will not be thanking the turkeys for the credit crunch and recession this year, but most may be thanking their lucky stars they've elected Barack Obama and his team. Like the Obama Government's first budget, however, turkey prices are up 8%. Rolls, cranberries, sweet potatoes and even pumpkin pie are also more expensive. Though if I had turkeys on my farm looking like this they could have the run of the garden and I'd never eat it, valuing its decorative value more.But, as in any recession, the higher prices are not showing up in corporate profit statements, and in the case of many banks the turkeys are not even showing up for work at all this Thanksgiving, a finance sector non-sequitor? What happened is that commodity costs like home prices rose faster than consumers are willing to pay, resulting in lower gross margins all round that threatens the solvency of turkey wholesalers and retailers. President Bush in time-honoured fashion will be using his Presidential Pardon to pardon several turkeys connected to his outgoing amionistration. But, first he gets to pardon a feathered turkey, pardoned. As usual in recent years, the lucky henbird is some luckless variety from some Guantanamo style white battery cage, looking cowed and fearful; wouldn't squawk at a goose or a Bush, very unlike the more traditional image of an organic bird in colourful plumage and bonnet-style headress. Financial turkeys of 2008 must include all the banks that lost most of their share price since August and those that faile doutright especially Lehman Brothers' bankruptcy, Paulson's Troubled Asset Relief Program which didn't exactly do what it said on the label, Merrill-Lynch spending $5.27bn buying its own stock at $84.88 per share (now $11.53), TPG (Texas Pacific Group) putting $7bn into WAMU 5 months before regulators wiped out shareholders, Fannie Mae and Freddie Mac, and AIG, and in Europe, the hapless demise of Fortis, Hyporeal, Dresdner, HBoS's botched share-sale and subsequent collapse followed by RBS and now Bank of Ireland looking like it might sell 2/3 of itself for even less good value than Barclays is getting for 1/3, and others too nauseating to recall, except for two recent bank closures. Regulators shut down Houston-based Franklin Bank and Security Pacific Bank in Los Angeles on Friday, bringing the number of failures of federally insured banks this year to 19. The Federal Deposit Insurance Corp. was appointed receiver of Franklin Bank, which had $5.1 billion in assets and $3.7 billion in deposits as of Sept. 30, and of Security Pacific Bank, with $561.1 million in assets and $450.1 million in deposits as of Oct. 17. The turkey here has to be co-founder and chairman of parent Franklin Bank Corp, Californian, Lewis Ranieri, who invented mortgage-backed securities two decades ago, but was unable to save his own company from getting ensnared in the home-loan bust.Today's economic news from Thanksgiving USA include the following: Not good news that new unemployment claims fell this week to 529,000 from 543,000 last week! US unemployment is now at its highest since 1983. Personal Income rose at an annual rate 0.3% in October, up from 0.1% in September, while personal pending fell 1% month on month, a big drop, largest fall since 9/11. But it tells us household savings are increasing. New Home Sales fell, confirming a 40.1% annual fall, lowest since 1982. Inventories are now 3 times that of good years (4 months worth of new sales). Orders for durable goods of all kinds fell 4-7%. There is however sign of a little recovery in consumer confidence, but it is likely to be temporary as rising unemployment has still some way to go. There are reasons to think that stock markets have become so cheap it may be profitable, very profitable to buy equities again. This is a global business. My personal view is that a 5-6 months bull run is possible, after which the markets should sag and fall again. The most important investor sentiment with global impact is that of the USA and it is showing a mixed picture with only a possible shading in favour of bullishness. My personal view is that this cannot begin to become solid until real estate prices bottom out and begin rising, at least look as if the fall-off is slowing and the market turning. If home prices are to fall to the long run trend they have to fall half as much again from the 20% fall to date. To end on a more festive note the following image was sent to me as a celebratory greeting for Thanksgiving, which I pass onto all my American friends.

Crunch Images of US Bank Sector Losses

2008-11-26T06:31:00.001-08:00

More Institutions Report Declining Earnings, Quarterly Losses: Troubled assets continued to mount at insured commercial banks and savings institutions in the third quarter of 2008, placing a growing burden on industry earnings. Expenses for credit losses topped $50 billion for a second consecutive quarter, absorbing one-third of the industry’s net operating revenue (net interest income plus total noninterest income). Third quarter net income totaled $1.7 billion, a decline of $27.0 billion (94.0 percent) from the third quarter of 2007. The industry’s quarterly return on assets (ROA) fell to 0.05 percent, compared to 0.92 percent a year earlier. This is the second-lowest quarterly ROA reported by the industry in the past 18 years. Evidence of a deteriorating operating environment was widespread. A majority of institutions (58.4 percent) reported year-over-year declines in quarterly net income, and an even larger proportion (64.0 percent) had lower quarterly ROAs. The erosion in profitability has thus far been greater for larger institutions. The median ROA at institutions with assets greater than $1 billion has fallen from 1.03 percent to 0.56 percent since the third quarter of 2007, while at community banks (institutions with assets less than $1 billion) the median ROA has declined from 0.97 percent to 0.72 percent. Almost one in every four institutions (24.1 percent) reported a net loss for the quarter, the highest percentage in any quarter since the fourth quarter of 1990, and the highest percentage in a third quarter in the 24 years that all insured institutions have reported quarterly earnings. Lower Asset Values Add to the Downward Pressure on Earnings: Loan-loss provisions totaled $50.5 billion in the quarter, more than three times the $16.8 billion of a year earlier. Total noninterest income was $905 million (1.5 percent) lower than in the third quarter of 2007. Securitization income declined by $1.9 billion (33.0 percent), as reduced demand in secondary markets limited new securitization activity. Gains on sales of assets other than loans declined by $1.0 billion (78.7 percent) year-over-year, and losses on sales of real estate acquired through foreclosure rose by $518 million (588 percent). Among the few categories of noninterest income that showed improvement, loan sales produced net gains of $166 million in the third quarter, compared to $1.2 billion in net losses a year earlier, and trading revenue was up by $2.8 billion (129.2 percent). Sales of securities and other assets yielded net losses of $7.6 billion in the third quarter, compared to gains of $77 million in the third quarter of 2007. Expenses for impairment of goodwill and other intangible asset expenses were $1.8 billion (58.6 percent) higher than a year ago. Loan Losses Continue to Mount: The industry reported year-over-year growth in net charge-offs for the seventh consecutive quarter. Net charge-offs totaled $27.9 billion in the quarter, an increase of $17.0 billion (156.4 percent) from a year earlier. Two-thirds of the increase in charge-offs consisted of loans secured by real estate. Charge-offs of closed-end first and second lien mortgage loans were $4.6 billion (423 percent) higher than in the third quarter of 2007, while charged-off real estate construction and development (C&D) loans were up by $3.9 billion (744 percent). Charge-offs of home equity lines of credit were $2.1 billion (306 percent) higher. Charge-offs of loans to commercial and industrial (C&I) borrowers increased by $2.3 billion (139 percent), credit card loan charge-offs rose by $1.5 billion (37.4 percent), and charge-offs of other loans to individuals were $1.7 billion (76.4 percent) higher. The quarterly net charge-off rate in the third quarter was 1.42 percent, up from 1.32 percent in the second quarter and 0.57 percent in the third quarter of 2007. This is the highest quarterly net charge-off rate for the industry since 1991. The failure of Washington Mutual on September 25 meant that a significant amount of charge-off activity was not reflected in the reported industry totals for the quarter.Growth in Reported Noncurrent Loans Remains High: The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) increased to $184.3 billion at the end of September. This is $21.4 billion (13.1 percent) more than insured institutions reported as of June 30 and is up by $101.2 billion (122 percent) over the past 12 months. The percentage of total loans and leases that were noncurrent rose from 2.04 percent to 2.31 percent during the quarter and is now at the highest level since the third quarter of 1993. The growth in noncurrent loans during the quarter was led by closed-end first and second lien mortgage loans, where noncurrents rose by $9.6 billion (14.3 percent). Noncurrent real estate C&D loans increased by $6.9 billion (18.1 percent), while noncurrent loans secured by nonfarm nonresidential properties rose by $2.2 billion (18.1 percent). Noncurrent C&I loans were up by $1.8 billion (13.7 percent) during the quarter. Nine Failures in Third Quarter Include Washington Mutual Bank: The number of insured commercial banks and savings institutions fell to 8,384 in the third quarter, down from 8,451 at midyear. During the quarter, 73 institutions were absorbed in mergers, and 9 institutions failed. This is the largest number of failures in a quarter since the third quarter of 1993, when 16 insured institutions failed. Among the failures was Washington Mutual Bank, an insured savings institution with $307 billion in assets and the largest insured institution to fail in the FDIC’s 75-year history. There were 21 new institutions chartered in the third quarter, the smallest number of new charters in a quarter since 17 new charters were added in the first quarter of 2002. Four insured savings institutions, with combined assets of $1.0 billion, converted from mutual ownership to stock ownership in the third quarter. The number of insured institutions on the FDIC’s “Problem List” increased from 117 to 171, and the assets of “problem” institutions rose from $78.3 billion to $115.6 billion during the quarter. This is the first time since the middle of 1994 that assets of “problem” institutions have exceeded $100 billion. Failure-Related Restructuring Contributes to a Decline in Reported Capital: Total equity capital fell by $44.2 billion (3.3 percent) during the third quarter. A $14.6-billion decline in other comprehensive income, driven primarily by unrealized losses on securities held for sale, was a significant factor in the reduction in equity, but most of the decline stemmed from the accounting effect of the failure of Washington Mutual Bank (WaMu). The WaMu failure had a similar effect on the reported industry totals for tier 1 capital and total risk-based capital, which declined by $33.6 billion and $35.3 billion, respectively. Unlike equity capital, these regulatory capital amounts are not affected by changes in unrealized gains or losses on available-for-sale securities. Almost half of all institutions (48.5 percent) reported declines in their leverage capital ratios during the quarter, and slightly more than half (51.2 percent) reported declines in their total risk-based capital ratios. Many institutions reduced their dividends to preserve capital; of the 3,761 institutions that paid dividends in the third quarter of 2007, more than half (57.4 percent) paid lower dividends in the third quarter of 2008, including 20.7 percent that paid no dividends. Third quarter dividends totaled $11.0 billion, a $16.9-billion (60.7-percent) decline from a year ago.

ART ATTACK!

2008-11-06T08:03:00.000-08:00

The world art market is now crunched too - another financial safe haven bites dust, or as I explained in a conference call earlier to my Paris dealers, "La question de la contagion de la crise financière au marché de l’art est désormais centrale." The signs began in September, though eminently predictable. Some observers claimed the art market had not contracted since 1990, which is nonsense. It declined in the mid-'90s after the 92-93 crash, which hit all luxuries, and again after 2001-03 when a lot of wealthy IT options earners suddenly got hit for capital gains as their share options crashed 90%. Although art values survived 9/11 (when several great collections and collectors were lost in the twin towers and a warehouse fire in East London destroyed a vast collection of Brit Art), the current meltdown of the global financial system has been too much for the "social climbers' investment" market. From January levels, the average prices of auction house art by October was 14.5% down, and that's without a short-selling market. In art all investors go long on illiquid assets and hope that windows of opportunity will suddenly open to sell at a euphoric profit. With hindsight, the market's peak was a year ago. Damian Hirst and Jeff Koons did well, however, before prices deflated. All market segments, all artists - from classic investment grade to top-end speculative to entry-level affordable (<$10,000) - are dragged down by depreciation of "speculative" works, what we financial analysts call high risk high return "Junk". Prices are down in small provincial auction rooms as at major prestigious houses. The value wiped out is undoubtedly in the region of $tens of billions. Demand as ever was driven by the nouveau riche, recently from among the arrivistes of Asia, Russia and the Middle-East that kept prices buoyant until June and allowed savvy Western collectors to offload. Mrs Richard Fuld was a little late into the market but others like Charles Saatchi and Richard Grant among collectors did well. The bought-in rate (buyers failing to come up with the final bid price) has more than doubled in one year, growing from 25% by value at the end of 2007 to 54% in October 2008. Paradoxically, the prices of works presented above the $100,000 line successfully sold remained stable. This is a time to market problem, the period of weeks or months between when works are valued to being published in catalogues to being competed for and orchestrated at the auction sale, so that price adjustments are slow to reflect the actual market. As reserve price estimates are behind market reality, the first supply/demand disequilibria causes a jump in the bought-in rate. I sold parts of my collection recently and had them converted into my own version of Carl Andre's bricks or Damian's skull. Whereas the top-end of the market (4.1% of deals) has shown relative and temporary price inertia, on the more volatile cheaper market segments (less than $100,000) falls have been frictionless and act as lead indicators, falling 18% year to date! We can expect at least the same again in 2009. But, long before prices fall further market illiquidity cuts off further sales other than fire-sales and insurance claims. The impact of the crisis has shaken boardrooms and drawing rooms around the world. The global market is efficient as prices contracted in New York, Paris, Berlin, Rome and London just as it did simultaneously in new growth zones of Hong Kong, Singapore, Shanghai, Tokyo, Sao Paolo, Bombay and Dubai. The very latest results recorded in these new markets are extremely disquieting to those who bought heavily into Chinese art this year on the back of the Olympics euphoria or the new nascent Gulf buying e.g. the $16.9m by Christie’s Mid-East in its October sales in Dubai compared with the $32-43m expected. In Hong-Kong in October '07, Sotheby’s posted a bought-in rate below 10%. A year later, at the same sales, the ratio was 29%. For long term proven fundamentals, if buying contemporary art on Walter Buffet principles, though I doubt he ever bought any investment grade art, I recommend the works of Joseph Beuys (1923-1986), something he'd explain on the blackboard and then have a good laugh at. He still appears in more art shows a year (360+) than Andy Warhol (350+), despite dying 2 years earlier, and the capitalisation value of his entire oeuvre has retained its museum price value of somewhere in the $6billions region. At the beginning of this year, many warned including myself that the art market would see contraction in 2008, notably as ArtPrice put it uniquely "via a recrudescence of buyer vigilance (that) could well start to manifest at auctions". 2009 looks set to be a year of steeper price contraction throughout the entire market. Buying at distress prices is a must for serious collectors. Any investors reading this may wish to join my Art Vulture Fund offering 10 year returns of 200-500%. During the contraction of 1990-92, prices fell 44% in 2 years. This time round I'm expecting 60-80% falls depending on the segment given that in the USA prices rose 67% in 2005-08 and globally (partly currency exchange rate movements) by 48.9% measured in Euros. Part of this year's fall is the strengtening dollar given that most of the worlds' serious collectors live in the USA. Hence high investment grade art can act as a currency risk hedge. Art outpaced equities, though underperformed property. But like any equity market individual gains can greatly exceed the market average or greatly undershoot it. Equity and fixed income markets tend to react immediately to announcements by the Fed, BoE or the ECB in seconds. The art market functions with a different rhythm but is at least as vulnerable to insider trading and system gaming. But more like the real estate market, the art market has a natural "interval" between cause and effect with transactions often taking several months to conclude.
This time round, however, the art market barometer dropped 13% at the start of October in unison with the sharp falls on stock markets. Such prices falls will not effect tight markets for great dead artists where the work is in short supply and hard to transport and the artists are widely popular such as Jean Tinguely who turn junk into fine art as opposed to those of a more semantic games-playing approach to art who churn out junk merely for investment. Below is Jean Tinguely's Homage to New York. This may be related to a change in the future evolution of art prices following several exchanges opening to trade art options and futures. Personally, I'm keen to develop an artist limited edition signed bearer bond certificates market price gurantee system whereby artworks can be effectively securitized and have their spreads insured. Whereas over the summer when I found less than a quarter of artists and agnts, gallerists and collectors would openly anticipate a contraction in the fourth quarter, in October at London's Frieze the proportion of bearish embracers of this idea rose to well over half.

McCain's had his oven chips

2008-10-27T04:20:00.000-07:00

Let's look at the big picture of US Presidential history. Obama was a shoe-in it seems, a dead-cert. McCain hadn't any hope remaining based on historical precedent, no chips left in his oven?
This was the 55th US Presidential election. Obama and McCain were competing to be the forty-third individual elected US President (44th Presidency) and to take the helm in leading the Free World out of Global Crisis. In may not be obvious to many, and comforting to some, but, with very few exceptions, all candidates lose who contest a US presidential campaign to succeed a president of the same party, unless the candidate is the outgoing Vice-president (happened 16 times beginning with the seven elected Presidents after the first, George Washington, who each had served as Vice-President or Secretary of State or both). The only exceptions to this that offered hope for McCain were Republicans, William Taft, Rutherford Hayes, his predecessor Ulysses Grant, and Democrat Herbert Hoover. But McCain is no U.S.Grant - for one quality not commonly known, Grant was very well read, a voracious reader of books, novels and histories as well as being a victorious General, which McCain is not, albeit a Vietnam War hero. Hayes lost the popular vote, but was controversially voted in 8/7 by an Electoral Commission of 8 Republicans and 7 Democrats. after a bitter dispute, bribery and fraud in the Electoral College. Could McCain steal the election by some such shenanigans; most probably not? Taft had been Secretary for War and was “a Progressive” and endorsed by the popular outgoing President Roosevelt (T). McCain could not match up to that though he tried to, but given Bush's deep unpopularity this was a losing proposition. Hoover beat a Republican Party divided internally by religion, having nominated a Catholic Candidate, Alfred Smith. McCain did hope (by his team or supporters employing McCarthy-style slurs) that the Democrats could be similarly divided between Clinton (H) and Obama, or divided over Obama’s race, middle name or partial anagram of his last name, or maybe by the fact that he is not obviously of Irish, Scottish, English, Dutch or Scots-Irish stock that are overwhelmingly dominant choices as presidential candidates, successful or otherwise, among whom Scots-Irish are pre-eminent by far, having been elected 18 times! Born in Panama McCain is, of course, Scots-Irish (with some French and Spanish). And, as it turns out, Obama had an ace up his sleeve by virtue of Irish roots on his Mother's side of the family.
There are those who value roots and today after Obama's victory these include Kenyans, Indonesians, and the Irish. McCain traces his line past his famous father and grandfather, both US Admirals, to a long descent from Saint David I, King of Scotland (d.1153 youngest son of King Malcolm Canmore, who killed King Macbeth, and St Margaret, descendent of the Hungarian Agatha) and from David’s grandson William the Lion, King of Scotland (d.1214). And he is also descended from 'Longshanks' the English King Edward I Duke of Aquitaine (d.1307), which does not play well with fans of the moie 'Braveheart', and Eleanor of Provence plus French descent from Louis VII, King of France (d.1180), and Spanish antecedents too from Saint Fernando III, King of Castille (d.1252), though this did not play well with the Hispanic vote who voted 65/35 for Obama. (Kingship is not new among the antecedents of US Presidents and candidates for the post; Clinton is in direct descent from a long line of Scottish gypsy kings). These days Royalty may actually count with Republicans, even bible-belters who voted 76/24, men 52/48, and whites 57/43 for McCain. These popular majorities in important oting segments were countered by first-time voters who voted 75/25, blacks 95/5, women 58/42, Jews 77/27, and American muslims and Red Indians both voting 90/10 for Obama. The Irish vote, worth one sixth of the total, seems to have split evenly, however, between McCain and Obama.
Obama is also blue-green Ulster-Scotch-Irish, if not so blue-blood as McCain, though of Irish and Cherokee and English stock on his Mother's side and having Afro-American and Afro-American and even Jewish antecedents in South Carolina, Illinois and Ohio. His father was a Kenyan Government finance ministry senior economist, and Harvard-educated, which is blue-blood enough for my vote in this financial-technocratic age. Sadly, the Cherokees did not factor highly in Obama's campaign, while full-feathered Indians provided the music after McCain's cncession speech rally in Arizona.
What is most intriguing, if one believes that governing elites tend to favour opportunities for their own, is how well-connected by those somewhat un-modern terms, pedigree and breeding, Barack Obama is by virtue of family connections to 8 US Presidents from Madison to Bush jnr and even Hollywood's aristocracy including Katherine Hepburn, Robert Duvall and Brad Pitt. All this was researched in immense detail by the New England Genological History Society goin back to the 17th century. Less impressive, but heart-warming, on the Irish side, one of Barack Obama's great-great-great-grandfathers was a shoemaker from Moneygall in County Offally. Ancestry.com revealed on March 12, 2007, it found records confirming Obama’s Irish roots (actually only 3.5% Irish and 3.5% Scottish while over 30% English). Canon Stephen Neill, a local Anglican rector, said church documents he found - along with census, immigration and other records tracked down by U.S. genealogists - showing that Obama's great-great-great-grandfather, Fulmouth Kearney (d.1878), a shoe-maker, came from Moneygall in Ireland. On March 20, 1850, a 19-year-old farm hand named Fulmouth Kearney landed in New York Harbor from famine-wrecked Ireland. He went to Ohio to live with relatives, married and had eight children. Three of his daughters married brothers in the Dunham family and one of them eventually produced Ann Dunham (Obama’s mother). The picture is of one of Moneygall's pub which was packed out by 100+ or a full third of the village population for a long caley (céilí or céilídh, meaning party, slender, and of the forest) on election night. Ann Dunham married a Kenyan economics student, whose father was a goat-herder, called Barack Obama and they had Barack Obama Jr. Henry Healy, a 22 years old Moneygall resident says his family records indicate he is distantly related to Obama. Like many Moneygall residents, he followed the U.S. presidential race more closely and rooting for his kinsman. "It would be brilliant if he won ... he is related to me, and also it would be good for the village." Julia Hayes, another Moneygall resident, says "I was hoping Hillary would get in, but now this has come up and I'd love to see ... [Obama] win." According to The Scotsman newspaper (6 Nov. page 9) "A small village is getting ready for an official visit from barack Obama. He had already signalled his desire to see his ancestral home in Moneygall, County Offally (population 299), and his US presidential triumph sent jubilant locals into a tailspin." The piece is titled "These Irish eyes are smiling".
This line of electoral logic reasoning, about McCain's poor chances of winning (substantiated by a 14-point lead in the polls that turned into a 5.5% margin win) may be suspected as just another inconsequential ‘urban legend,’ though such legends need not be dismissed so lightly. The most powerful example of such legends, the most chilling, must be Shawnee Chief Tenskwatawa’s "curse" (upon his military foe General, who later became President, Harrison). Tenskwatawa (or his brother Tecumseh) cursed any US Presidents elected in a year ending with the number zero i.e. every 20 years (which has turned up 8 times so far) electing that they will die in office. This “zero-year curse” “came true” for Harrison (elected 1840) and for the next six zero-year presidents - Lincoln, Garfield, McKinley, Harding, Roosevelt (FDR) and Kennedy. Ronald Reagan (elected 1980), among other accomplishments, “broke the curse” by surviving an assassin’s bullet (by being taken to a private rather than a state hospital), and so too, so far, has George W. Bush (elected 2000). It must nevertheless be a comfort to President Obama (who heard of the chants 'Kill Obama' at a McCain rally and complained about this at the second Presidential debate) that the next zero at the end of the year is 2020 when everything will become much clearer, by virtue of course of 20/20 hindsight, including knowing by then just how bad the curse of our present financial and economic crisis really was!

Financial Culloden!

2008-10-14T11:48:00.000-07:00

The humiliation of both the Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBoS) is complete. The Scotsman Newspaper (Bill Jamieson's column) posits that "As time passes, we will view it as a financial Culloden" (when the mainly Scottish Jacobin army led by The Pretender, Prince Charles Stewart, was defeated by the mainly English and Scottish Hanoverian army led by the Duke of Cumberland). We hope that the fates of RBS and HBoS will not be decided by today's leaders of these forces, Jacobite First Minister Alex Salmond and Hanoverian Prime Minister Gordon Brown? For an account of the coming battle read this excerpt from an as yet unpublished history of the events of October 2008, 262 years after the first battle of Culloden whose illustrations it employs:
"English poured forth their incessant fire of treasury bills notwithstanding the canon of the Golden Rule, now loaded with political sour grapes at the loss of Scottish Parliamentary majority, that now swept aside the Scottish banks like just so many chips off a gambler's card table, and like a hailstorm notwithstanding the flank-fire of the City of London upon the Edinburgh regimen that led the Bill Jamieson's Scotsman (whose front page on the cold grey morning of the 15th trumpeted the call "Still time to save 'The Bank') and all ranks of Scottish patriots hurtling onward and down the slope, as like to the headlong rush day after day of the banks' share prices, dividend-deprived shareholders now desperately flinging themselves into the stern credit lines of the enemy, which indeed they did not see clearly for smoke 'n mirrors of the death-knelling paperwork of back-room agreements signed as if in blood. All that courage, all that despair, could do was done. It was a moment of dreadful and agonising suspense, but only a moment for the credit crunch whirlwind does not reap the forest of share certificates and annual reports with greater rapidity than short-sellers cleaned out the Scottish banks. Nevertheless, almost every man in the shareholders' ranks, chief and gentleman and gentlewoman, fell before the deadly squeeze which they had braved; and although the enemy gave way at minor points along the line, it was not till every rule of shareholders' rights was bent and screens ran red like so many a bloody knife. When the first lines of equity capital and the SLS credit swaps had been swept aside, the defenders of the independence of Scottish banks continued their impetuous advance till they came near the second line of preference shares, when, being almost annihilated by a profuse and well-directed short-selling and panic dissertions, the shattered remains of what had been ever victorious until barely a few months before, now facing a suddenly much more numerous and confident force, began to give way. Still a few political leaders, institutional shareholders and their journalist comrades rushed on, resolved rather to try negotiating the steely points of the enemy than forfeit their well-acquired and dearly-estimated honour of their fair value portfolios. They rushed on, but not a man ever engaged fully with the main force of the enemy's tactical logic. The proud Scots who had innovated all that was at one time new in world banking such as trustee savings, joint stock banks, paper money, double-sided printed banknotes, colour bank notes, bonds, Adam Smith, mutual funds and much else, now found themselves losing at a global chess game that was no longer theirs to influence or command.

The last survivors of that fatal accounting, at the end of what had been a 300 year drama, their pride, dreams and hopes perished more assuredly than on any battlefield as they reached the points on the London government's agenda where Nationalisation would be temporary until all assets and lines of business of any value remaining were sold off at auction prices or given away to foreign interests. The wailing and moaning in Edinburgh and Glasgow's restaurants, bars and drawing rooms could be heard unremittenced for many years after, though it was many years too before a Labour Party again ruled in Scotland."

Hidden Agendas?: New Bank Note (Turkish) & ringing up Clause 3

2008-10-13T02:42:00.000-07:00

The UK Labour Party's public agenda for nearly a century contained Clause 3 (rescinded under the leadership of Tony Blair) that expressed the aim of taking into public ownership the heights of the economy, though after the '50s more observed in the breach than the observation. The crisis of Britain's banks has resuscitated this political corpse as a hidden agenda with the possibility of government taking a commanding ownership share of leading banks (though only if existing shareholders do not take up the bulk or all of the preference shares that 4 UK clearing banks are about to issue)? The reality may be more symbolic than having long term political consequences. So long as UK banks only survive by government guarantees government dilution of existing shareholders' rights seems only fair (and the conditions such as no more "rewards for failure", and banks must not reduce lending to small businesses or first time home-buyers). It's not really fascinating therefore, as many journalists are suggesting, to wonder how Gordon Brown and Alistair Darling square this having long abandoned youthful left wingism. Paradoxically, the same is happening in the USA. In recent decades, it became axiomatic that whatever happens in the USA is copied in the UK afterwards, rarely beforehand. Nonetheless, there is a symbolic change going on in the social dimension of the role of money. In the realm of symbolism, with the popular mind ever seeking after archetypal storylines about the credit crunch, asking who are the good guys and the bad guys, journalists seek out poetic truths for which, for example, the demonic looking image of Richard Fuld (ex-CEO of Lehmans) is very satisfying. It is another sign of the times that in Turkey a secular revolt is splitting the republic over placing the image of a "previously obscure" woman on new banknotes? She is Fatma Aliye (d.1936), Turkey's first female novelist, illustrated without the Islamic headscarf! The integrity of money is at the centre of politics, never more so than today, but rarely as a battleground between religious conservatives and feminism. Aliye was the daughter of a senior Ottoman bureaucrat and historian. New notes are being minted for issuance next January to mark the inauguration of a fresh currency to replace the existing New Turkish Lira. The central bank committee also chose a mathematician, a composer, an architect and a 13th-century Sufi mystic. These are all departures from the established practice of notes carrying political figures. Having women depicted on banknotes other than merely for allegorical purposes is very rare. Other countries have political female figures such as England's Queen, Mrs Bandaranike, Indira Gandhi, and Israel's ex-President Golda Meir (below). Placing non-political women on banknotes is rare. England had Florence Nightingale on the back of a ten pount note. Last year North Korea also for the first time placed a woman on a note (below). The new Turkish note echoes a Chilean note (above) showing Gabriela Mistral, pseudonym of Lucila de María del Perpetuo Socorro Godoy Alcayaga, a Chilean poet, educator, diplomat, feminist, and first Latin American to win the Nobel Prize for Literature, in 1945. My vote for the world's greatest ever banknote is the Clydesdale £10 for reasons I explain below. Scotland has 3 sets of sterling banknotes (issued by 3 banks) and Northern Ireland gloriously has 5 sets. Except for the Hong Kong dollar, these are the only regional banknotes left in the world (all the result of a freedom won by Sir Walter Scot's defence against moves by the Bank of England in the 1820s to impose only its banknotes on the UK). All this is against the background of de-nationalised Euro notes that only show 'bridges' as communitaire symbols, though if the UK does join the Euro zone the Irish and Scottish banks in the UK will gain a unique right to design the back side of their notes.
The Clydesdale note is unique for showing Africans on the reverse and a map of part of eastern Nigeria! Other than its predecessor that had David Livingstone in Africa have there ever been any countries' banknotes that show images from foreign countries? The current note shows Mary Slessor whose story is told in all Nigeria's schools. She was a Scottish presbyterian missionary who went native in Calabar and in time stopped the Nigerian tradition of rejecting twins as a curse, which was an immense age-old tragedy in a country with the highest birth rate of twins in the world. The bank note looks African and has no Scottish references or symbols other than the names Clydesdale and Glasgow. I consider it the Clydesdale note as the greatest medium of exchange. But, who today thinks of money as having symbolically important, educational or political dimension on a par with the most scandalous of contemporary art? There is the story of French PM Lionel Jospin, who on his first meeting with PM Tony Blair objected to the Bank of England note depicting the Duke of Wellington on the reverse of the £5 note with the Battle of Waterloo. This note, like the choice of Waterloo as the terminal for the Chunnel train connection between London and Paris, was a humorous studied insult that coincided with the opening of the Channel Tunnel rail link. After the meeting it was replaced with a subtler points-scoring, with a note depicting George Stephenson and the world's first railway just to remind the French tourists who invented railways. I suppose these themes are capable of expressing hidden agendas, of the sort that nationalisation of banks are being suspected of by died-in-the-wool conservatives, though how hidden can they be when handled by millions? In Turkey, Bedri Baykam, an artist and member of the pro-Atatürk Kemalist Thought Association, says the new Turkish note is part of an AKP-driven hidden agenda. "I have no problem using historical figures on bank notes but I don't trust the motives," he told the Guardian. "They will infiltrate through the currency names or images that at first look harmless but the next step will be to introduce gradually more conservative figures until you get people who negate the values of the republic." Well, for now, anything thought-provoking and culturally radical I can only celebrate, though why except for Golda Meir, the other women depicted should all have to look so glum I have no idea. I'd prefer the image that this blog begins with for Mary Slessor with her adopted twins on the Clydesdale note.

A USA Short Seller's Diary 2

2008-10-10T10:27:00.000-07:00

Yippee we're out of the SEC's sin bin, no more timeouts, back in the thirties big game, shorts rule, slam dunk every Morgan Stanley put! Inflation in the nation don’t bother me, cause I’m a scholar with a dollar, as you can plain see. Guess who wrote that song? Shaft - I'm showing my age -. At Dow 14,000 I got laughed outta the dealing room for calling Dow at 9,000 (P/E's at 9) or less as a first stop, now it's below 9,000 and I'm cashing in profits the whole way down. At 5,000 (P/E's will be 5) and would be historical bottom, but now let me shout my call m- Dow 4,000 in two years or sooner in fast market time, every month only a week, week after week, every day a week, day after day, a day is an hour, hour after hour, Bloomberg and CNBC bring it on - their show me market bottom-seers! Jerk after jerk sees a bottom beginning 5,000 points ago. First problem, these fools believe their own propaganda. But, Propaganda's meant for the enemy, the retail schmucks who the market professionals are tsuccessfuly stuffing. Second problem, 99.99 % of experts in this speculate to cremate business think the world is linear. How often do I preach to the trough, pearls before swine, that the linearity coefficient is pure bs, only for future states of the world? Turn on the TV talking heads on the propaganda screens and I bet you’ll hear tomorrow: “after the market falls this far, it will most likely do this or that in so many days.” Arrgh. these idiots savants should be taken off the air because they are contributing to the economic plunder by Wall Street's downhill slalom champeens. I still think there is room in EWG puts (Germany), although who am I to suggest that? I bought Ultrashort SDS and DXW Dec.85 calls (remember to think inverse, calls because this is a short fund) at $3.14 and sold them at $6.40 and was feeling pretty smug about $32 grand smug until they closed next day at $29.50, which means for every contract I left about $2,300 on the table, and I had 100 contracts. I couldn’t help it because I had a big Lehmans party to take my girl to and go pfisching some some insider steers from guys who technically are no longer inside. She had her fourth date with me and I hope she’s gonna commit now, because this dating is costing me a fortune in bar tabs alone. Anyways, next day
I bought Potash puts today POT and they popped $10.00 per contract – that’s $1,000 per put. Not bad at all. I’ll got out because I wouldn’t be around next trading day tomorrow but hey everyone take a look at POT. I warned the guys about Met Life and it dived by ½ in value making me some weekend money. Same happened to Prudential when it dropped $10 in half a day. Take another look at Priceline – no not travel? They got into toxic mortgages and crashed by ½ in 10 trading days, but do not qualify to go to The Fed's Pre-Xmas Santa Claus window. On the positive side, I bought AXA April 35 calls because AXA is one of a few solid companies around that was wise to bail out of the US. Next stop, the Euro at 2 bucks. The only thing with AXA is that the pit trader is a crook and tries to take me by making spread way too wide. I Stayed away from gold. Chumps couldn't understand that when poverty beckons, pawnbrokers make a killing buying in gold cheap. I read this summary, which goes "If you were filled with whiskey for a few weeks and are now sober and someone tells you the current market summary, where do you think gold would be? $5,000?" Think what happened until now?
[1] Eight Fed rate cuts, the last of which was globally coordinated;
[2] creation of two alphabet soup special lending agencies (TAF, TSLF),
[3] nationalization of mortgage giants Fannie/Freddie,
[4] takeover of worlds largest insurance company (AIG),
[5] seizure of 7th largest US mortgage originator (IndyMac),
[6] government bailout ($700 billions + $150 bill.),
[7] loosened Discount Window borrowing parameters worth maybe a $trillion?
[8] paying interest on the Fed's reserves,
[9] direct purchase of commercial paper from private companies.
[10] Dow heading way south of 9,000!
Instead of $3-5,000 Gold iss gonna languish and maybe even fall as poor folk sell to the man at the booth counter. The fact that gold isn’t at maybe even $10,000 – and is still below recent highs – means it AIN'T the refuge “experts” say. When people need cash they’ll sell everything, including gold, in fact gold first, and they sure ain't buying it for a rainy day or Xmas. Short, bay, short, and in the short-term – a new meaning for short-term – even a dead cat can bounce by the half day, sometimes in the half hour. Gotta go back into the dealing asylum, my shorts, CFDs and puts are about to pay hard cash on the nail. People think I'm a derivatives trader, but really I'm strictly cash; cash in and cash out every day, day after day, sometimes hour by hour, doing my bit for Obama's election hopes. Ya gotta be a turkey who votes for Xmas not to!

A is for Assets e.g. Art?

2008-10-09T06:48:00.000-07:00

It was announced today that savvy nvestors will from Friday be able to bet on the price of art, when Dublin's Intrade’s The Prediction Market begins trading futures contracts – which can be bought for as little as $30 – based on the art market prices (Mei Moses All Art Index). This is definitely shutting the stable door stuff. How much longer can the art bull market last before turning into the art bs market. But if there is a turning point coming up that makes derivatives a very interesting gamble for bulls and bears and even for collectors to seriously think about hedging their asset risk exposures. How will Intrade fare if it finds itself on one side of a lot of contracts in a one-way market. Spread-betting might be a safer form of derivative speculation in art, but for that to occur art prices would have to be quoted via buy-sell spreads on reputable (regulated) auction based exchanges. The art market is not yet that liquid or the underlying that homogeneous. There are at least a 100 global brand names however where such liquidity may be achievable? But, aggregating any artist's prices across all his works to calculate a single index per artist is a dark art, though one that at least half a dozen information services claim to have cracked and these may all be correlated within Mei Moses All Art Index? This is not about art; it is about money, and therefore I'd have to be convinced that price discovery could not be distorted by any one artist, dealer or collector?
Art has been traded as an investment for years even if never fully accepted by banks as investment grade against which any were prepared to lend money other than in special circumstances a few private banks. This always seemed silly to me as lending up to 25% of the auction house value of works by household name artists always seemed a safe bet to me. High risers other than the creme de la creme of the classics have been post-WWII American Expressionists, Pop Art (e.g. Warhol) and contemporary Pop Art that is often mistakenly called conceptual (e.g. Hirst who sold $178m this year of which $111m at auction) and Kitsch Art (e.g. Koons, $47m this year in sales) and Asian derivatives (e.g. Chinese). Both Hirst and Koons are reputedly $billionaires and they are not the only ones; so too are many collectors and more than a handful of gallerists. For years it has been possible to follow price trends, do charting and detect buy and sell signals for thousands of artists and millions of works of all kinds. The two artists with the biggest number of shows a year (over 350) are Beuys and Warhol (both 20 years dead). In Beuys' case (he being the most complex and multifaceted of all artists since Da Vinci) his total oeuvre is worth some $6bn+ but most of it by value lies in large public and a few private collections. The total capitalisation value of investment grade art is undoubtedly somewhere in the low $trillions with 90% locked up in museum collections. In Switzerland alone this decade some $5bn is being inherited by the next generation of collectors. There is money in them thar hills but only for the most intrepid; not many can become a Saatchi or a Count Panza or a Guggenheim, or a Mrs Richard Fuld.
The Intrade contracts start trading tomorrow. The move is said to be part of the trend, if a bit late in the day, for art to be viewed as an asset class with the development of art funds and art prices indices. Art funds have been around for a long time and some beauties are about to be unloaded in the auction rooms. It is a luxury and illiquid market however that is very sensitive to only the last prices for directly comparable items at the last auction. This is an asset class with a myriad of sub-classes - hard to commoditise and standardise. Like property it tends to be a long term play except in brief periods of market hype - usually when somewhere in the world there is a sudden production of nouveaux riches. When the dot-com bubble burst in 20021, the art market cried collectively as $billions in stock options that would have been converted and spent in the world's art markets suddenly were worthless. The fact is this can also happen to the art if you borrow heavily to buy it and can't afford to wait for years for prices to recover after a fall.
I've often advocated that artists and galleries whose revenues are volatile should issue bonds when they sell artworks offering to buy them back for a certain price in 10 years thereby doing two things, avoiding tax and putting some certainty into the market.
Chad (hanging) Rigetti, VP Bus. Dev. at Intrade, said: “The idea to create a price-transparent, liquid tradable art-based derivative occurred to me after reading about hedge fund billionaire Kenneth Griffin’s purchase of Jasper Johns’ ‘False Start’ for $80m in the fall of 2006 ... Creating a product that would bridge two circles – collectors and financiers – seemed obvious.” Haha - a ptltab deriv. might work since it is not cash market invested which would be beyond most people's wallets. He said investment strategies had become increasingly quantitative, and at the same time high-end art was being bought by people who had made money from such strategies. He thought these people would be natural candidates to buy art futures contracts. Of course, why not; Quantity over quality has got to work every time. “There has been an influx of financially savvy and technically savvy investors, which has led to the demand for this type of instrument,” he said. Yes, but where's the pleasure in hanging a derivative instrument on the wall that is not signed by the artist?

Prez candidates 2nd debate

2008-10-08T02:51:00.000-07:00

Scarcely had the 2nd Presidential debate ended than I received an email saying,
"Yes We Can: Voices of a Grassroots Movement is a moving musical tribute featuring the inspirational speeches of Senator Obama interwoven into music created by today's top artists including Sheryl Crow, John Mayer, Kanye West, Stevie Wonder, Jackson Browne, John Legend, Lionel Ritchie, Jill Scott, Los Lonely Boys, Bebe Winans, Yolanda Adams and many more. In a collection as diverse as the campaign, these artists have captured the spirit, themes and ideals at the core of this historic movement for change. This beautiful album is not just fun and inspiring to listen to, it's also a great organizing tool.We hope you enjoy this landmark project." See and hear: http://www.battem.com/
Why am I not remotely shocked or amused by this? The debate might as well have been replaced by a battle of the bands, both teams' pop music brands slugging each other with bubblegum lyrics, for that was the level of the debate, no offence intended; this is the new norm of prime-time politics. What of great import was said, no not said but gleaned by reading between the autocue briefing teams' parrot-puppet lines?
There is a major ideological divide between M and O (and between their respective parties, parties that neither candidate mentioned by name along with not mentioning a lot of other nono words and names.
No mention of the EU, UN, recession, TARP, liquidity, solvency, credit markets, budget balance, GDP, fiscal, monetary, dollar, war on drugs, international cooperation, free trade, free markets, capitalism, socialism, communism, liberals, China, India, trade, Japan, Asia, Mexico, Latin America, Canada, California, New York, Florida, stolen elections, migrants, black, hispanic, white, my executive team, Supreme Court, the Constitution, Sarah Palin, USAAF, the Marines, missile shield, or the G8 - except whether to kick Russia out of it.
They did mention bipartisanship, banks, war on terrorism, Al Qaeda, Taliban & others, growth, Arizona, Delaware, Tennessee, Russia, Georgia, Ukraine, Estonia, ex-Soviet Union, Putin, Korea, Iran, Iraq, Afghanistan, Pakistan, Rwands, Somalia, Congo, Lebanon, democracy, peace, holocaust prevention/ intervention, our troops, navy, medical insurance, education, middle class, which means blue collar, poor people, food stamps, cutting spending programmes, lower taxes, higher taxes, protecting Main Street, my voting record, your voting record, fundamental change, GWBush's 8 years of questionable or failed policies, Ronald Reagon, Teddy Roosevelt, Joe Biden, refundable tax credits, tax credits, veterans, spending freeze on everything except military, energy, oil dependency, nuclear power, off-shore drilling, alternative renewables, Climate Change, future generations, our great country, love, privilege, rich people, small businesses, mandating policies or not, when I am President, toughness, hand on tiller, decisiveness, experience, my wife, all children, tough problems ahead, talking soft, big stick, and Israel.
M believes in not increasing any spending programmes except on the military and veterans and is keen to cancel something called earflaps (incidental items) that O says are only worth $18bn. Refundable tax credits are M's solution for Medical Insurance - note 'refundable' (a word concept that O did not challenge). Economic means $300bn higher rate tax cuts, mainly company taxes. M wants to withdraw from Iraq (and Afghanistan) only with big surge victory and honour. Also, more oil drilling to reduce energy dependency and nuclear power plus alternatives.
O believes in no tax increases for 95% of people and businesses and higher taxes on the richest 5% and big corporations. He wants children's education subsidised more, and medical insurance extended to all currently uninsured paid for by tax credits (voluntary for anyone otherwise insured). O wants managed withdrawel from Iraq and Afghanistan when the war effort can be handed over to local national government. He wants more green energy but is ambiguous on drilling beyond saying it can't solve the problem. He wants fundamental change in Washington but what that means is unknown. He will regain international respect for the US in foreign policy, but will do whatever it takes to get OBL and destroy Al Qaeda etc. and will not tolerate nuclear rocket capability in Iran that threatens Israel's destruction.
That's about it I think?

Talk delivered to the von Poser Society of Edinburgh at the height of the sub-prime crisis

2008-10-07T11:16:00.000-07:00

Sub-primus mammonistus inter pares sperate miseri caveat felices sic transit gloria mundi
“We here discuss great matters and one matter contemporaneous our Society can be right proud of, is the absence off our balance sheet of sub-primes, SPV’s, or anything mortgage-wise, and it falls to me being unregulated to tell the unvarnished of it, sub-prime being somewhat the lesser of prime, meaning first among equals, when I am often asked what is it I do, a matter on which The Grand Secretary graciously recently reassured my investors just as I was packing for the Aegean to study the crisis from its earliest beginnings in The High Hellenic when banks were temples, since when as many will agree with me the general laity has roundly embraced secularism, treating assets and liabilities as if day into night phenomena are mere fluxions from trading coal-tar by-products or the high price of vegetables, likening volatilities to fainting-fits caused by corsets or double-entry book-keeping, why depositors finger-wag at salami slicing bankers as Adam Smiths and Physiocrats pun daily in the FT that dead cat bounces are catatonic, and claiming unsanitary conditions are upon us like a lung collapse after a years of wheezing, while I blame buy to lets bankrolled with all the circumspection of ankle-biters in sweetie-shops, or those who covet assets without walking banker’s walk, talking the talk, as in President’s words “Again and again returning to the distances…”, infra-visually speaking, to explain dark matters, usually after teatime when New York opens for the afternoon session and dark pools sweep up fungible losses to sell on to gullible Asians, not really triple or even double A, the 'only drinking straw offered' to use a wry cocktail phrase pertaining to ABS’s in SPV’s that were by definition incombustible until now being consumed daily in flames ignited by defaults that were 0.8% to 2.15%, now rising 3 to 20 times higher, intenser, like luminance in the vacuum of a standard light-bulb or the striking mismatches of credit ratings that all knew to be dodgy as yields & spreads high and low all narrowed to AA+, and the Chief Auditor’s warnings went unheeded, puncturing the cycles of rocket scientists, drive chains coming off and gearing useless, and as I set out for Central Asia banks my solution, to bottle written-down tranches in deepest caves, if only I had not said as the Irish delegate* “this reminds me of old MacPhillemy of Balinrobe, of no NPV to any but himself, coffined after a good day at the Curragh and then passing out in McDaids, who would have remained so had the Mask not burst its banks to flood the churchyard and he found floating on Lough Robe, in sum and in all aspects defining a genuine liquidity crisis,” but then I had been copied in on the Phrygian words of our Midas King Merv, code in clear, I quote, “Darling, sir, as matters stand res cogitans our dark bottlings in bonded warehousing may make little headway in the present headwinds of the sub-primal storms, yours Mervyn” followed shortly, on my return, by my apprehension by officers in the lounge of the Sheepdip, via Regia, during the Northern Rock Run and my own letter to the FT as to how liquidity loss in interbank markets coincides with months of incessant rain flooding millions of homes with effluence and others with cheap credit, explaining** that sub-primes are Greek myth, a taxonomic ploy by Standard & Poors, Moody and Fitch in a pass the parcel scam, though my editor H.Dobbs says the tragic tone is too knowing to be shocking, and he a member of the Speculative, who in the French edition uses 'prêt penoirs hypothécaire à haut risque' to mean 'high risk sub-prime mortgages hypothecated” over a trillion dollars by Connecticut’s Le Shred who, as his share price collapsed, told me “as you know yourself this is so far beyond a banker’s conscience… inasmuch as one being unable to say aught charitable or useful it behooves us to preserve the darkness of it at all costs” and that just about clarifies the whole dark matter!”
Prof. McDowell
* to the Baktrian Monetary Conference in Bukhara
** see my ‘Liquidity Crisis: how they bottled it’Failsafe Press, 2007
(with apologies to the footnotes in Flann O'Brien's The Third Policeman)

Congressional 3rd Degree

2008-10-07T10:38:00.000-07:00

Congressional equiry yesterday called in Richard Fuld who headed up Lehman Brothers and sought to paint him as the very face of the greed that caused the whole of the financial crisis. The hearing took place just as stock markets plunged to new historical lows in New York. Q&A snippets include:
Rep. Henry Waxman (D-Calif.), the chairman of the House Oversight Government Reform Committee, "Your company is now bankrupt and our country is in a state of crisis - but you get to keep $480 million! I have a very basic question for you: Is that fair?"
Fuld (66') took off his glasses, squirmed, squinted and looked away for a pause moment before muttering something about stock options. Waxman interrupted him to list highlights of Fuld's high lifestyle that includes a $21m Park Ave. flat, a $14m oceanfront Florida estate, other vacation homes, and his wife's multi-million-dollar art collection (which I have to say shows great taste and fine judgement, the art collection that is, containing superb American expressionist paintings and drawings by Arshile Gorky and de Kooning).
"Is that fair for the CEO of a company that is now bankrupt to have made that kind of money? It's just unimaginable to so many people?" Fuld mulled for a good reply.
"I would say to you the 500 number is not accurate. I believe the amount that I took out of the company is a little bit over $250 million!" Fuld's face sans pancake looked like a Hollywood horror creation and could never betray any suitably redeeming emotions during the 2-hour hearing. He explained his bonuses were in stock and he was left holding 10 million worthless shares when the firm failed.
"I was probably the single largest individual shareholder!...I don't expect you to feel sorry for me." Not a good line, not how he said it, and while he had not asked what his motivation in this scene should be, he was told.
Rep. John Mica (R-Fla.) "If you haven't discovered your role, you're the villain!" This may have been a reference to the fact that when the 158-year-old firm went down (for about the third or fourth time in its history) thousands of shareholders were wiped out and Lehman employees alone lost $10bn in shares never mind unpaid wages and bonuses (possibly another $3.5bn), but then it is uncertain how many of those no-one should feel sorry for either? CNBC had reported earlier that same day that on Sept. 21, Fuld was on a gym treadmill when a weightlifter walked over and knocked him out cold, which may explain why employees said he he was nowhere to be seen at the moment the company collapsed. Fuld insisted Lehman never misrepresented its finances and said the SEC monitored the firm closely, which may mean Christopher Cox should have something to say too about this.

Diary of a US Short Seller

2008-10-06T09:06:00.000-07:00

Hey, I bought QQQQ December BL puts at 2 cents and sold them today at 50 cents! But, mostly now I use options, not CFDs, and mostly put options on market indices, sectors and specific companies that are bound to suffer in an economy with broke consumers. My basic view is to look for the truth away from public pronouncements. I think the U.S. unemployment rate is about 3 times the official figures. If you cannot find a job after a few weeks, you are not counted? I made money on Bear, Lehmans, and a bunch of other banks like HBOS, but not just financials. I rode Apple down from 160 to 100. Not in a straight line - I was in and out sometimes within hours. If I had more time and depper funds, I might have risked some of these switchbacks rides with my life's wad, but with lives laying all about here in psycho-anxiety fragments gnawing at dwindling portfolios, I kinda hold back so the other guys in the dealing room don't see me shorting their stocks.
I usually look at the market ex-post, post facto, form an opinion and enter open orders with stops. I also shorted Boeing as there is no new giant orders on the horizon, or anything that would make a difference this quarter. It is beyond me why the stock was up, other than God Save America stoopidity - which is fine with me as I get to fleece the deserving flag-waving sheep. Thursday I read about stocks that will suffer on account of a slowdown in construction and supplies to local builders and contractors. So, Friday I bought puts on Texas Industries for a mere measly few thousand dollars, like ten, and by the end of the day had a profit of $200,295. Not bad for a few hours. I made tons on shorting market indices, and found the QQQQs specially suitable. I also had what we now call BLn puts on the Dow. Old timers used to call them Kamikaze puts. Even the crazy crap shoot BL puts made a heap of money. I also buy the odd call options because if I've committed all my resources and don't have enough left to commit to stocks. Sometimes I am on both sides, such as riding as short-term gold or oil move versus a longer option that will bounce in my direction as soon as the euphoria du jour is over. Currently, I am short Germany and long Russia and Korea. I have a load of Canadian resource stocks that are really in the category of "buy and forget" but there seems to be life in them thar hills, such as First Calgary Even got a German windmill and Vietnamese oil stock - when I was wanting to ease out of anything stateside. When I pick up the next round of funds, I plan to separate pure trading focus from buy and forget and act more decisively. For example, I bought Metchel Steel calls the day before Putin made noises about them - I took it in the shorts on that one and didn't have time to get out because I was analyzing Mittal to short them. Is anyone liking Metchel Steel at these levels? MTL. They are building lots of highways in Russia, more cars on the road, bigger buildings. They just took a big kick in the pants from the Kremlin, and it looks like that is the only kick they are going to get. But, from here out, I see prospects either way. So I said 'what the hell, hold' and they are slowly creeping back tho' I'll prolly still take a hosing on those. I am also taking a monster crap on shipping stocks because I went with near maturities. But despite the bad trades, I was still up over 45% in September. I like agri stocks but it's the wrong time of year unless you are a long term holder - for me long term is 1 month or so. So, I might buy 10,000 or 20,000 shares of something like Vostok or Black Earth and forget about them. I still believe we are headed down sharp until late October before we get a bounce. I've for the longest time predicted first stop for the Dow at 9000 this year - now on the horizon. In 2 - 4 years we'll mebbe see 4,000 unless there's a miracle turnaround?

Bank of America is The One...

2008-10-06T09:02:00.001-07:00

see
http://uk.youtube.com/watch?v=wmIObmv2t6M

TARP saviours

2008-10-06T08:50:00.000-07:00

To see whose votes counted in passing TARP by switching sides see:
http://www.washingtonwatch.com/blog/2008/10/05/a-bailout-rogues-gallery/

DEAD PARROT

2008-10-05T22:33:00.001-07:00

CEO (Banker): Bank's closin' for a clean-up of all its assets 'n liabilities.
Mr. Praline (regulator): Never mind that, my lad. I wish to complain about this 'ere bank what we purchased half of not half a day ago in this very office.
CEO: Oh yes, the, uh, our FN bank...What's,uh...What's wrong with it?
Mr. Praline: I'll tell you what's wrong with it, my lad. The General Ledger, it's insolvent, that's what's wrong with it!
CEO: No, no, 'e's uh,...it's squeezed, gone off-balance, it's the credit crunch.
Mr. Praline: Look, matey, I know a dead bank when I see one, and I'm looking at one right now; it's my job.
CEO: No no it's not dead, er insolvent, it's, it's re-settlin'! Remarkable bank, the FN, isn'it, ay? Beautiful assets!
Mr. Praline: The assets don't enter into it. It's insolvent, stone dead, unable to trade, can't meet obligations.
CEO: Nononono, no, no! We're settling, rebalancing, talking to creditors!
Mr. Praline: All right then, if you're settlin' current liabilities, I'll re-settle some right now, this way up! (finger pointing at the balance sheet) 'Ello, ello, what do we see 'ere for the general ledger! Our generous fresh liquidity injection for you; where is it now, can you show me if you're solvent... (thumps the table)
CEO: There, see that, we've paid for all that with it and proved those estimates!
Mr. Praline: No, you didn't, that's a lie, was you using our cash to make up the collateral figures to be higher!
CEO: I never!!
Mr. Praline: Yes, you did!
CEO: I never, never did anything...
Mr. Praline: (yelling and hitting the accounts ledger repeatedly) 'ELLO 'ELLO THEN WHERE'S THE ACTUAL COLLATERAL!!!!! Testing! Testing! Testing! Testing! are you receiving? This is your audit calling. It's an INSOLVENCY alarm call! (Takes a page out of the ledger and tosses it to the head of the table, up in the air and watches it drift to the floor.) Now that's what I call a dead bank!... You got nothing to say?
CEO: No, no.....No, I'm just stunned!
Mr. Praline: STUNNED?!?
CEO: Yeah! Your remark stunned me, just as we're reviving the business, getting back up again. We're too big to fail! We bankers in these turbulent times are proud of our history and sensitive to criticisms, and yes I'm stunned; we stun easily, Mr Regulator.
Mr. Praline: Um...now look...now look, mate, I've definitely 'ad enough of this. Your bank is definitely insolvent, deceased, and when I purchased half of it not 'alf a day ago, you assured me that its total lack of movement, in fact even reducing liabilities ratio to assets was due only to your accounts people not getting the true figures!
CEO: The new CFO bein' tired and shagged out, we all have, following a prolonged run on the bank's share price. Well, he's...we's, ah...probably pining for the old days, way it was before all this Basel II capital reserve stuff, RWA, PD and all that.
Mr. Praline: PININ' FOR THE OLD DAYS BEFORE BASEL II, YOU DON'T EVEN MEET BASEL I REQUIREMENTS?!?!?!? What kind of talk is that?, look, why did ALL the profit disappear the moment we got the to see the current accounts?
CEO: The Netherlands bank prefers t'keep sweating its assets to the max! Remarkable bank, id'nit, squire? Lovely assets, very valuable!
Mr. Praline: Look you, I took the liberty of examining those accounts when I got the 49% deal signed, and we discovered the only reason that the bank appears profitable in the first place was that you've been LYING there, there, and there! (pause)
CEO: Well, fair value o'course; it was estimated there at fair value! If we hadn't estimated that at fair value, it would have eaten up all our capital, rent the business asunder, and no VROOM VROOM anymore! Faretheeweel bank, bank gone!
Mr. Praline: "VROOM"?!? Mate, this bank wouldn't "vroom" if you put forty billion Euros through it! It's bankrott, bleedin' capital's gone, equity dematerialised!
CEO: No no! It's only a capital reserve thingy; we're refinancing!
Mr. Praline: You're not refinancin'! 'You've bled to death, unpaid debts passed on to us! This bank is no more! It has ceased to be! Your license's expired and gone to meet its granter, us! We've bin stiffed on yesterday's deal! You're bereft of capital totally, the rest, what's of value, is in pieces! If you hadn't misrepresented the accounts, the bank'd be buried, pushing up the daisies already, maybe sold to someone better, safer! Its operations in this country far as you're concerned are now 'istory! You're off our authorised banking list! You've kicked the bucket, shuffled off this mortal coil, it's curtains for you, you've just become a shadow bank, joined the choir invisible!! THIS IS AN EX-BANK!!
Apologies to Fortis - NOT!