Category Archives: Moral hazard

Satyajit Das: Controlling Sovereign CDS Trading – The Dysfunctional Debate

By Satyajit Das, author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming September 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

In an opinion piece entitled “Hedging bans risk pushing up debt costs” published on 9 March 2011 in the Financial Times, Conrad Voldstad, the chief executive of the International Swaps and Derivatives Association (“ISDA”) and formerly a senior derivatives banker with JP Morgan and Merrill Lynch, made the case against the EU ban on “naked” credit default swap (“CDS”) contracts on sovereigns.

Just as “patriotism is the last refuge of a scoundrel”, arguments citing market efficiency and the benefits of speculation seem to be the first resort of dealers.

Why is a Powerful Faux Liberal UK Think Tank Using a Tarnished Pol and Recycled US Republican Talking Points to Fight Breaking Up Banks?

By Richard Smith

The publication of a pamphlet from Demos, a British fauxgressive think-tank (unconnected with the American think-tank of the same name), is the latest visible move in a not-always-public epic battle between banks and regulators about bank reform. While Americans may assume that the time for regulatory intervention has passed, the preliminary findings of the Independent Banking Commission, a UK body whose output will put an important stake in the ground in the UK, is to be released on April 11th. Whatever mix of legislation, regulation and inaction is deemed appropriate by the politicians will follow the publication of the final IBC report in September.

Given the importance of this report, it should come as no surprise that the banks, or rather the bank that has most at stake, Barclays, is using every available channel to convey dire warnings about how terrible reining in the banks would be, particularly since the banks are really hardly at fault at all.

A curious centerpiece of this effort is this 100 page abortion of a pamphlet, penned by a fallen Labour MP (the usual expense account improprieties), Kitty Ussher.

Do We Need Big Banks?

Yves here. I normally let VoxEU articles stand on their own, but this topic, of whether the bank PR that bigger banks are essential stands up to scrutiny, is near and dear to my heart.

Note that the authors point to a 1990s study that finds that a $25 billion in assets bank was the optimal size. There were a fair number of studies done then of bank size versus efficiency. I’m a bit surprised that this is the one that is most often cited, since it also came up with the biggest size threshold at which a negative cost curve kicked in (meaning the bank became more costly to run). One study found that the slightly negative cost curve started at $100 million in assets (!); more typical was somewhere between $1 and $5 billion. And remember, these studies were done in the days when banks returned checks, and check processing was believed to have strong scale economies (ie, if check processing was a bigger proportion of total costs then than now, it could arguably have increased scale economies).

Some academics were frustrated with these results. I recall reading a paper where the author argued that there were theoretical cost savings to being bigger (duh) and basically contended that the empirical data had to be wrong.

Remaining Staff at Fukushima Plant Told to Leave (Temporarily?); Intrade Predicts IAEA Will Upgrade Accident Level (Updated)

Markets like Intrade are only as good as the intelligence (as in G2, not IQ) of the people making the bets. Given the dearth of real information coming from Tokyo Power, it’s hard to reach informed conclusions about whether the powers that be are making progress in getting the damaged reactors in the Fukushima power complex under control. Japanese are just not big on Western-style disaster presentations: “Here is what happened,” (with a few schematics) “here is what we’ve done and this is what we are going to do next” with backup plans sketched out if the first line of attack fails. Their reflex is instead a combination of apologies and sincere vows to do better, plus and inward hiss if they are asked a really uncomfortable question. So the collective nervousness is based on the legitimate concern that Something Really Awful still could happen, and the incomplete and often inconsistent tidbits don’t provide much reassurance.

Why Adulterous Failed Banker Sir Fred Goodwin’s Covered-Up Workplace Affair is a Matter of Public Interest

We will probably see in the next few days whether the newspapers manage to get the super-injunction by Sir Fred Goodwin, the CEO of failed bank RBS, lifted. Since the facts of the matter, or “speculation” if you will, are now all over the Internet, keeping the super-injunction in place seems pretty pointless, as the Telegraph confirms in Sunday’s Links.

So what’s the real point of this circus? A demonstration of the superiority of the Web over the tabloid press as a mechanism for transmitting salacious tittle-tattle? A grandstanding MP working parliamentary privilege to get a bit of banker-bashing publicity? Naked Capitalism getting into the regulatory arbitrage game and thumbing its nose at the UK court order from the relative safety of its NYC-hosted web server? Or perhaps it is blogger Guido Fawkes sarcastically pointing out that the law is now officially an ass:

So there was this ****** bloke who worked closely with another ****** colleague, they apparently began an adulterous affair not long after the ****ing crisis of 2008. He went to Court to stop it getting out that he had been banging her. Because he is the most notorious ****** of his generation he also banned references to his profession lest he be identified. Guido would be in contempt of Court if he told you his name or profession…

Indeed, the law should not be mocked; but who’s mocking it? The UK certainly needs major overhauls of its privacy (and libel) laws, rather than the current abusive shambles, but in this particular case, one might contend that it’s Sir Fred who’s doing the mocking.

Paul Jackson Claims It’s All About the Money

By Richard Smith, a recovering capital markets IT specialist Housing Wire’s Paul Jackson has another post up continuing his row with Yves over securitization chain of title issues. It presents itself as a rebuttal of her previous post, about an Alabama trial court decision that Jackson deems to be a significant defeat, but which Yves […]

Gillian Tett on Losses at Central Banks

Is the old Gillian Tett back? The one-time Financial Times capital market editor has taken to writing less frequently (understandable now that she has head the US operation) and less intrepidly (much of her commentary was prescient, particularly on my pet topic, collateralized debt obligations).

But her latest piece sounds a wee warning, and it’s one we’ve commented on as well, namely, that central banks are vulnerable to losses, and just like the banks they mind, may need a rescue by taxpayers if the err badly enough.

Her object lesson is the Swiss National Bank. Unlike most central banks, the SNB is quite transparent, and publishes periodic statements of the value of its assets on a mark to market basis. The usually conservative SNB made a uncharacteristically aggressive move last year, intervening in currency markets in an effort to suppress the value of its levitating franc.

Even though the locals applauded the move, the central bank was outgunned by currency traders and threw in the towel mid year. As the swissie continued to rise, the bank showed losses at the end of 2010 of SFr 21 billion. The only saving grace was that the gains on the bank’s hefty gold positions exceeded the damage. But that does not reassure its shareholders, who have become accustomed to annual payments out of bank “profits”, and are concerned that the profits this year will be too meager for them to enjoy their customary level of income.

The Project Merlin Back Story

Not a bad couple of week’s work for the banks, since the “Project Merlin” publicity? Actually it’s taken a bit longer than that, and reconstruction of some of the behind-the-scenes action might be instructive. Although other banks get walk-on parts, the story is mostly about Barclays. Let’s start the timeline in September 2010, when John […]

King Dinged

Soon-to-be-unemployed sports team managers the world over know what it means when they receive an affirmation of full confidence from the club chairman. Accordingly, we know roughly what to make of this: ‘The Bank of England has credibility,’ said Osborne (pictured). ‘I have complete confidence in it.’ The chancellor will not alter the 2% inflation […]

George Osborne Channels Bob Diamond; that won’t End Well

Here’s Bob, on the 12th of January, thumbing his nose at the Treasury Select Committee: The new boss of Barclays refused to bow to demands by the MPs that he waives his 2010 bonus, which could be as much as £8m. He said he had forgone his bonus in 2008 and 2009 and would decide […]

Satyajit Das: Derivatives Regulation Dance

By Satyajit Das, the author of “Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.” Cross posted from Wilmott

A question of values …

Derivative contracts are valued on a mark-to-market (“MtM”) basis. This requires valuation of the contracts based on the current market price.

OTC derivatives trade privately. Market prices for specific transactions are not directly available. This means current valuations rely on pricing models.

There are significant differences in the complexity of the models and the ability to verify and calibrate inputs. More complex products used sophisticated financial models, often derived from science or statistical methodology. There are frequently differences in choice, exact factorisation and even numerical implementation of the models. Different dealers may use different models.

Some required inputs for the models are available from markets sources. The nature of the OTC market and the limited trading in certain instruments mean that key input parameters must frequently be “estimated” or “bootstrapped” from available data. In certain products, the limited number of active dealers means that “market” prices are sometimes no more than the dealer’s own quote being fed back after being collated and “scrubbed” by an external data provider. This is referred to prosaically as “mark-to-myself”.

Barclays’ Bob Diamond to Non-Bankers: Drop Dead

Bob Diamond, Barclays’ chief executive officer, no more said something as inflammatory as “drop dead” to the UK Treasury select committee yesterday than Gerald Ford did in a 1975 speech refusing to extend financial assistance to save New York City from bankruptcy. But the substance was every bit as uncooperative.

Despite its artful packaging, Diamond’s presentation was yet another reminder of the banking industry’s continued extortion game, namely, that they can take outsized, leveraged risks and when they work out, pay themselves handsome rewards, and when they don’t, dump them on the taxpayer. And they’ve only been encouraged to up the ante. Not only did they get to keep their winnings from their last “wreck the economy” exercise, no senior executive was fired, no boards were replaced, and UBS was the only major bank required to give a detailed account of how its screwed up so badly as to need government support. And before you tell me Barclays was never bailed out, tell me exactly how well it would have fared had any other major UK or international bank failed, or had the officialdom not provided extraordinary liquidity support when interbank funding dried up.

JP Morgan Markets Its Latest Doomsday Machine (or Why Repo May Blow Up the Financial System Again)

By Richard Smith

Readers of ECONned will be very familiar with the name of Gary Gorton, author of ‘Slapped in The Face by the Invisible Hand’, which explores the relation of the so-called shadow banking system to the financial crisis. His work is pretty fundamental to understanding some of the mechanisms which made the crisis so acute. Now he’s done an interview, which I would like to have a growl at.

It also happens that JP Morgan, originators of those not unmixed blessings, Value-At-Risk and Credit Default Swaps, are also thinking hard about how to get rehypothecation going in the grand style. They know a volume business with a cheap government backstop when they see one; they are on a marketing push, and presumably they have the systems and processes that go with it. That would be a Doomsday Machine…