A year ago, I found Gillian Tett, then the Financial Times’ capital markets editor, to be the single most useful financial reporter by a considerable margin. She gave insights into areas that were important but badly neglected elsewhere, such as CDOs, credit default swaps, SIVs, all well before they entered the mainstream lexicon.
She was promoted. While she may add value behind the scenes, her stories this year are a shadow of her former work. And that’s being polite.
Consider her offering du jour, “How talking can help cut the risk of a lemming fall.” Here’s the set-up:
Imagine for a moment that you are a banker, who stumbles across a juicy new instrument called the “lemming” product that your sales team could sell to retail clients – for a fat profit……even though it has been rubber-stamped by your compliance department….investors will suffer big losses if stock markets fall more than 30 per cent.
….over 70 per cent of the audience [in a Securities and Investments Institute conference] voted to block the lemming deal in an anonymous poll, taken after the participants had discussed the issue with neighbours.
But then the organisers presented a chart which highlighted a more sobering point: when the SII has done these tests before, it has typically found that the proportion of bankers who block risky trades falls dramatically when participants do not discuss the issue with their neighbour first – even if they vote anonymously.
Tett uses this example to conclude that what investment banks need isn’t better incentives, but (to use that horrid American term) more dialoguing:
….bankers should be forced to talk about their business with a wide pool of colleagues, including those outside their immediate silo, rather than just their bosses alone.
Rubbish. A conference is such an artificial setting that to generalize its findings to the day-to-day operations of a company is fantasy. People want to look good before their peers, and in a weird bit of self-deception, once someone takes a position publicly, they typically find it difficult to recant privately. And here, the tradeoff has been framed in uncharacteristically black and white terms: big profits versus big downside to clients in relatively low-odds situations. Would the response had been different if the question has included: “the odds of the market falling 30% in the next X year is Y”? Yes. Survey results are HIGHLY influenced by the wording of the question. So just imagine how susceptible real world situations are to subtle and shifting pressures.
Take the lemming. The response of a manager/department head in the real world no doubt will also be shaped by:
How tough standard disclosure language would be
What leadership in the lemming might do for league table rankings
How close your team is to being on track for its targets for the year
Whether your boss is satisfied with you these days
Whether your firm has had a major compliance/litigation problem in the last two years
Whether you sell to retail clients directly (ie, you own them) or primarily via other firms’ salesforces
Whether other firms are selling lemmings actively. This is probably the biggest single consideration. There is far less perceived risk if others are already in the pool
Tett also argues that Goldman, an example of better practice, engages in just this sort of debate:
Institutions such as Goldman Sachs, for example, try to ensure that different business silos have ways of watching what each other does. They also invest heavily in creating a holistic risk management culture: Goldman Sachs’ risk systems, for example, are run by Gerry Corrigan, the former New York Federal Reserve president, who makes a virtue out of sticking his nose into as many dark corners as possible – and trying to encourage companywide debate.
Tett has the causality backwards. Goldman still carries the legacy (now weakened since it went public and is dominated by the trading side) of being extraordinarily risk averse and image conscious. The firm when it was a partnership went to unusual lengths to make sure that even very junior staff understood the finer points of legal and practical liability. This was pragmatism; the partners regarded it as a cheap form of insurance.
The firm in the 1980s was also cautious about delegating decision-making authority to client facing staff that other firms delegated routinely (such as not letting investment bankers quote indicative prices for financings) and about putting capital at risk (it was late to book interest rate swaps). When its practices became visibly uncompetitive, it generally came up with a solution, or at least a finesse. Goldman is an inwardly-focused firm that takes few mid-career hires, so its culture is reasonably intact. The structure is a product of the culture, not vice versa.
Something this misleading from a formerly keen observer is surprising and disheartening. She needs to get back out and mix it up with her source more often.
The FT has displayed quite a lot of courage confronting the market worst practices headfront.
I have alas little doubt that this free-speech has a high cost. And that it may be receding already for some obvious commercial reason.
BoE free speech also a significant cost. But I dearly hope the City will undestand how critical it is to avoid getting in the trap Wall Street is making for itself:
-complacent press and media,
-a “business banker” (please excuse my coughing) at the head of the treasury (wrong naming by the way),
and last but not least,
-a fairly absent judicial institution.
What has happened in the CDO field deserved AT LEAST some highly visible litigation in US courts and extensive cover in international media.
International investors (excuse my coughing) will vote with their feet.
I’m sure you know that what the courageous league of outspoken bloggers you proudly belong to along with Roubini and quite a few others (read most of them) is bringing in terms of awareness will not make up for the folly of the last 4 or five years.
“…investors will suffer big losses if stock markets fall more than 30 per cent….”
Just to be clear, these products exist and have been sold to retail clients in Europe.
A little less greed and a little more common sense might be helpful in preventing financial disasters from recurring, but I guess that would be asking too much.
Though I am least of all things a lawyer, it would appear that the CDO structures were designed _specifically_ to make it difficult to litigate into them. If you get a prospectus, and buy a tranche it will, it seems certain, cost you more in billable hours than your sunk cost to squeeze a nickle out of the securities trust. This, is seems to me, twas the point: fragment, fuse, and lock diverse asset risks in an entity that spits out revenue streams, leaving any one who doesn’t like it to contest an entity without equity holders or clear title to the underlying assets. CDOs are risk-shredding machines; not risk-eliminating or risk-recycling but paper trail shredding machines. I’m sure that their underwriters see that as a magnificant innovation, don’t you agree?
“A” is correct that the instrument Tett refers to is not hypothetical. In the UK, banks have sold and currently sell retail investors instruments referred to as structured capital at risk products (SCARPs) or precipice bonds, which is sort of like a bond with a yield that is juiced because the holder’s effectively getting a premium for writing a put against some equity index falling below a predetermined barrier (30%, 60% or whatever). Investors want stuff like this that offers a shot at high yield, despite the risks. Unless you have some kind of paternalistic regulator that prevents investors from buying stuff like this, someone will always sell it.
I could be mistaken, but it seems that Yves just called for her to engage in more dialogue.
I’m afraid to say Yves that you have been giving Ms Tett too much credit in the past. On that basis I can understand your disappointment. You may (or, more likely, may not) remember that I wrote a couple of comments slating her journalism around the time that she was wrting on SIVs and CDOs. At the time I found a number of her efforts to be factually incorrect, easily recognised by anyone who has experience in the area. To her credit, she did learn about the sector by the end, but the impact of her scare-mongering (and those of her ilk) were not insignificant in the loss of confidence and associated shock waves in global credit markets. IMO, if someone else has converted to the “she doesn’t know what she’s talking about” camp, all the better. Funny how quickly people come to that conclusion when she starts to write about their specialist subject.
Hi Yves. Sorry to disagree but I am in one of those firms being referred to and Gillian is correct in what she says. There is a silo problem where the different functions do not communicate properly. Sometimes each function has a concern about a proposed product, but individually approve it. However, if you get them to discuss with one another, then you may get a different result.
If you think about it, some sales person or structurer is highly ($$) incentivised to get the product approved. Whereas the other functions are not similarly incentivised to stop dangerous products. In fact, they also lack a clear decision-making framework. If I use a risk-return framework, to make a sensible decision, I need to incorporate financial risk, reputation risk, regulatory risk, counterparty risk and so on into my decision. I can’t do that and make the trade-offs if I’m not getting all that information.