Category Archives: Regulations and regulators

Questioning Goldman’s “Market Making” Defense

The notion underlying the Volcker rule is that too big to fail institutions have a government backstop and therefore their activities should be restricted to the types of intermediation that support the real economy. The taxpayer has no reason to fund “heads I win, tails you lose” wagers. Various firms, most notably “doing God’s work” Goldman, has tried to play up the social value of its role, whenever possible wrapping its conflict-of-interest ridden trading activities in the mantle of “market making”.

A big problem in taking about market making versus position trading is that, Goldman piety to the contrary, the two are closely linked. Even though all the major dealer banks created proprietary trading operations to allow top traders to speculate with the house’s capital, plenty of positioning also takes place on dealing desks. While dealers are obligated to make a price to customer (well, in theory, it’s amazing how many quit taking calls in turbulent markets), they are shading their prices in light of how they feel about holding more or less exposure at that time. And the dealing desks, just like the prop traders, are seeking to maximize the value of their inventories over time.

A Goldman discussion of risk management presented yesterday (hat tip reader Michael T) gives reason to question that much has changed on Wall Street regarding the role of position taking, now taxpayer supported, in firm profits.

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 […]

Is AIG Getting Yet More Presents from the Treasury, Meaning the Chump Taxpayer?

On the one hand, as we pointed out, the Treasury has from the get go of its ongoing rescue of AIG engaged in continued subsidization of the giant insurer, starting with the all too frequent restructurings of its financings. The net effect was not simply to provide more dough to the AIG, but to put the taxpayer in a worse and worse position. The taxpayer effectively owned AIG, with the first financing secured by all the assets of the company and further holding 79.9% of the equity. The first rule of being a creditor in a troubled company is that you want the most senior position in the capital structure, always. That rule was repeatedly violated with AIG.

The latest until now took place in the pre-IPO restructuring, which looks to have provided a further $6 billion to AIG.

Mirabile Dictu! SEC is Taking a Hard Look At Bad Mortgage Practices

While it is far too early to break out any champagne, the Powers That Be seem to be taking notice of the continuing train wreck in courtrooms all over the US as far as banks’ ability to foreclose is concerned. Apparently, the American Securitization Forum’s “Drive on by, nothing to see here” mantra is becoming less and less convincing with every passing day.

It’s worth nothing that only the Financial Times seems to be carrying this story (yours truly did check on key word variants in Google News and came up empty-handed). They also deem it to be worthy of front page placement. This is only an isolated sighting, but one of the features of the runup to the financial crisis was an ongoing news disparity between the Financial Times and US business press, particularly the Wall Street Journal. The FT would pick up on stories that seemed important and were too often either completely ignored or reported by the American financial outlets only in in a selective manner. So if we see more bypassing of inconvenient news by the usual suspects in the US, take heed.

What is particularly interesting is that the SEC seems to be targeting specifically the sort of abuses that we have chronicled at length on this blog…

The New York Times’ Half-Hearted Hatchet Job on the Bank of England’s Mervyn King

By Richard Smith, a UK based capital markets IT specialist, and Yves Smith

It’s always a fraught business when a foreign paper hazards into parsing UK politics. But one has to wonder at the unseemly spectacle of the Grey Lady giving such a distorted reading on Mervyn King, the governor of the Bank of England.

Were you to rely on the New York Times story on Monday, “A Crisis of Faith in Britain’s Central Banker,” you would think that this central banker is under assault on all fronts. While most of the article is on his fiscal/monetary policy stance, where King is taking a great deal of criticism, it also leads readers to believe he is isolated on bank reform as well. These are the first and third paragraphs of the piece:

Goldman “Partner” Hedging Circumvents Intent of Pay Reforms

While I don’t want to overdo the criticism of Wall Street pay practices (on second thought, I am not sure such a thing is possible), I’d be remiss if I neglected to highlight a very good job of analysis and reporting by Eric Dash of the New York Times (and Footnoted.org) on this topic.

The Times has been picking apart a partnership that Goldman preserved after it went public in 1999 and is the vehicle that holds stock options and shares allotted to the top producers of the firm, a 475 member group. It already holds 11.2% of the firm and its share is likely to increase as options vest.

The report published tonight reveals that members of the Goldman partnership would routinely hedge their Goldman exposures. That defeats the purpose of share grants and equity linked pay.

The Specious Logic of Wall Street Pay

It’s remarkable how Masters of the Universe, the new financial elite first identified by Tom Wolfe in 1986, remember nothing and regret nothing. And why should they? Their position remains remarkably secure 25 years later.

We see the “Who us, take responsibility for our actions?” stance in full view courtesy one of their most effective spokesman, Steve Eckhaus, an attorney who has negotiated many big ticket Wall Street compensation contracts. From the Wall Street Journal:

“It was understandable why there was anger,” says Mr. Eckhaus, but “the crisis was not caused by Wall Street fat cats. It was caused by a confluence of economic, political and historical factors.”..

In general, he said his clients are “pure as the driven snow” and doing work that supports the economy and justifies their pay….

“You have to know what the profits are” to know what someone should make, said Mr. Eckhaus, noting Wall Street’s top performers usually gobble up 80% of the bonus pool. “Those who are responsible for profits should share in the profits in a way that rewards them.””

This is the usual “heads I win, tails you lose” logic. The rationale for bulging pay packets is that the producers created it, therefore they deserved their cut. But Eckhaus says any bad events are due only to bad luck. Sorry to tell you, but only narcissists and their agents take credit for good stuff and lay the blame on everyone else. Unfortunately, we breed for that in Corporate America, it happens to be a very effective career strategy in large organizations.

Wall Street Co-Opting Nominally Liberal Think Tanks; Banks Lobbying to Become New GSEs

One of my cynical buddies often remarks, “Things always look the darkest before they go completely black.”

His gallows humor comes to mind as a result of the hushed conversations inside the Beltway around GSE reform. While the shiny bright object these days in DC is health care repeal, or perhaps Egypt, in quiet corners in think tanks and trade associations the bankers and their allies are getting ready to appropriate themselves a permanent US credit card worth trillions of dollars. The dynamic that became all too familiar during the bailouts is about to repeat itself.

Barney Frank’s great moral passion is low-income housing, and that’s not an accident. The traditional alliance in financial politics since the 1950s was between liberal low-income housing advocates and Wall Street financiers. Since the 1970s, Democrats tried to balance the two sets of interests by creating consumer protections but allowing the capital markets to manage themselves. This dynamic has created a serious political problem in the last four years, because complete capitulation to the banks in the capital markets has pillaged the low-income and middle-income communities the Democrats thought they were standing up for.

It’s not that the people who made this Faustian bargain are bad so much as they are fundamentally irresponsible and childish. The breakdown of law and order in the capital markets arena has created predatory lending, and ultimately has subverted any attempt to implement new laws. Dodd-Frank not just a weak response to the crisis, but actually downright pathetic thanks to the lack of prosecution for anyone who breaks the rules set forth in the bill.

And so, we return to the reform of the GSEs.

Josh Rosner and Your Humble Blogger Discuss the Roots of the Financial Crisis on Radio Free Dylan

In addition to his weekday television show, MSNBC host Dylan Ratigan also has a regular radio/podcast. He interviewed Josh Rosner and yours truly on the origins of the financial crisis, which we both agreed started well before the housing bubble.

You can read the transcript at the site, but it has quite a few errors, and I’d recommending listening instead. Rosner is an emphatic, almost theatrical speaker, so I think you will enjoy the conversation.

Get the podcast here: http://www.dylanratigan.com/wp-content/uploads/2011/02/RFD-Ep-25-Rosner-Smith.mp3

A Whole Bunch of Prominent Economists Backs the Use of Capital Controls

A letter signed by over 250 economists opposing restrictions on capital controls is more of a shot across the bow than it might appear to be. The letter with signatories appears here, and it includes highly respected trade and development economists like Ricardo Hausmann, Dani Rodrik, Joe Stiglitz, and Arvind Subramanian; we are reproducing the text below:

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”.

FCIC Report Misses Central Issue: Why Was There Demand for Bad Mortgage Loans?

By Tom Adams, an attorney and former monoline executive, and Yves Smith

In common with other accounts of the financial crisis, the Financial Crisis Inquiry Commission report notes that mortgage underwriting standards were abandoned, allowing many more loans to be made. It blames the regulators for not standing pat while this occurred. However, the report fails to ask, let alone answer, why standards were abandoned.

In our view, blaming the regulators is a weak argument.

A much more sensible explanation can be found by asking: what were the financial incentives for such poorly underwritten loans? Why would “the market” want bad loans?

All the report offers as explanation is that the “machine” drove it or “investors” wanted these loans. This is lazy and fails to illuminate anything, particularly when there are other red flags in the report, such as numerous mortgage market participants pointing to growing problems starting as early as 2003. Signs of recklessness were more visible in 2004 and 2005, to the point were Sabeth Siddique of the Federal Reserve Board, who conducted a survey of mortgage loan quality in late 2005, found the results to be “very alarming”.

So why, with the trouble obvious in the 2005 time frame, did the market create even worse loans in late 2005 through the beginning of the meltdown, in mid 2007, even as demand for better mortgage loans was waning?