naked capitalism

Goldman and Barclays are out touting old structured credit technology, apparently collateralized debt obligations, and claim they have been tamed and repurposed and are now virtuous.

I am skeptical of these assertions, and welcome informed reader comment. CDOs in particular were leverage on leverage vehicles, and indeed, that seems again to be the reason for turning to a variant on that theme again, to minimize equity requirements.

The amusing bit is these news structures are argued to be “transparent.” If you buy that, I have a bridge I’d like to sell you.

If you have a dog’s breakfast of assets, some of them tranches from other deals, and then you tranche that, what good does transparency do? It’s a complicated mess to analyze. Opening the hood does not make it any more comprehensible to anyone other than an industry expert equipped with specialiazed software and access to sources that help him come up with default and loss probabilities. Most investors and all regulators will find them impenetrable. Which is precisely the point. I wonder if the assertion of transparency is Emperor’s new clothes in action, designed to cow those who can’t fully grasp the workings of these vehicles.

But the cheery sales talk is just breathtaking. You’d think it was spring 2007 all over again. Maybe that’s the objective.

From the Financial Times:

Investment banks, including Goldman Sachs and Barclays Capital, are inventing schemes to reduce the capital cost of risky assets on banks’ balance sheets, in the latest sign that financial market innovation is far from dead.

The schemes, which Goldman insiders refer to as “insurance” and BarCap calls “smart securitisation”, use different mechanisms to achieve the same goal: cutting capital costs by up to half in some cases, at the same time as regulators are threatening to force banks to increase their capital requirements.

Yves here. You gotta love the attempt at rebranding established technology. Back to the story:

BarCap’s structures involve the pooling of assets from several clients into a secured financial product that can be sold on to other investors and rated by a credit rating agency, potentially reducing the capital allocated against the assets by between 10 per cent and 50 per cent.

These new mechanisms are in some respects similar to the discredited structured products, which were widely blamed for fuelling the financial crisis. But the schemes’ backers argue there are two significant differences. First, they involve the securitisation of banks’ existing assets, rather than of new lending. Second, bankers argue that the new products do not disguise the transfer of risk….

However, some regulators may be wary of the invention of new pooled asset derivatives, especially if they are perceived as a way to avoid regulatory capital requirements.

Some rival bankers also view the schemes with scepticism. “This is a system of capital arbitrage,” said one senior banker at another investment bank. “The need for capital just miraculously disappears.”

BarCap has worked on portfolios worth hundreds of billions of pounds in recent months, including those of the Barclays’ parent company. Investors in the securitised products typically include the original banks, plus third parties, such as hedge funds and private equity firms, as well as BarCap itself.

Separately, Goldman is working on what bankers said was a private-sector version of the UK government’s asset protection scheme. The goal would be similar – to reduce the capital that would need to be held against the assets – although Goldman has yet to find a balance between the risks and rewards that would be attractive to investors.

Yves here. That is code for “Goldman is spinning its wheels.” I’m surprised they’d noise this up with the media if they hadn’t come up with a viable solution. Hhm, are we back to the MLEC problem, which no one can ever solve, that no matter how much lipstick you put on these pigs, there is an unsolvable price gap between what bank owners of the paper are willing to sell it for and what buyers are willing to pay? Back to the story:

Investment banks do not believe they can compete with the government-sponsored APS, mainly due to scale. RBS and Lloyds between them are putting £560bn ($914bn) into the scheme. Under Goldman’s idea, it would sell an insurance product to a bank with a toxic portfolio, effectively shifting the risk of the underlying assets off the balance sheet. The insurance would require far less capital to be carried against it than the original assets.

Deutsche Bank engineered a comparable structure to facilitate the dismantling of risk at failed insurer AIG, although bankers close to that transaction said without government involvement the cost of such a structure would be commercially unfeasible.

The Lex column adds:

Those clever investment bankers are at it again. It was surely only a matter of time before banks tried to apply their financial innovation skills to finding ways of profiting from the very crisis that misuse of those skills brought about…

On one level, such initiatives might be welcomed as industry practitioners try to find a market solution to their own problems, reducing the need for taxpayer-funded bail-outs. But there are dangers here. As studies of the origins of the financial crisis such as the UK’s Turner Review have concluded, one of the keys to creating a sounder banking system is increasing the quantity and quality of bank capital – which also, of course, means lower returns. Since the new schemes being developed are designed to cut the capital cost of risky assets, they potentially go against the spirit of such proposals.