Category Archives: Risk and risk management

Felix Salmon Misreads AAA Bond Demand to Say “Overcaution” Caused Crisis

Lordie, I can’t believe someone who professes to understand markets has written, at length, that caution, no, “excess of overcaution,” was a major contributor to the criss. Or has Felix Salmon been spending too much time with lobbyists from ISDA and SIFMA?

I hate seeming rude, but Felix has a habit of tearing into Gretchen Morgenson for errors much less significant than the one he made in a post today. He wrote, apropos this chart, which comes from FT Alphaville:

Satyajit Das: European Debt – Wrong Diagnosis, Wrong Treatment!

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

Executed with Northern European creativity, charm, flexibility and humility and Mediterranean organisation, leadership diligence and appetite for hard work, the European rescue plan – “the grand compact” – is failing.

Did Sheila Bair Save the US From Complete Financial Meltdown?

When a moderate (meaning anachronistic) Republican proves to be a more tough minded regulator than Democrats, it serves as yet another proof of how far the county has moved to the right. Bair, in a long “exit interview” with Joe Nocera, says a number of things that would have been regarded as commonsensical and obvious in the 1980s, yet have a whiff of radicalism about them in our era of finance uber alles. For instance: Bear should have been allowed to fail, TBTF banks are a menace (well, she doesn’t say that, but makes it clear she regards them as repugnant), bank bondholders should take their lumps.

Bair was alert to the dangers of subprime, having recognized how dangerous it could be in the early 2000s (when a smaller version of the market blew up, taking homeowners along with it), and was not a believer of the Paulson/Bernanke party line that subprime would be “contained”. She long championed mortgage mods as better for lenders, borrowers, and the economy, and has fought an uphill battle with the Administration on that front. With the IndyMac failure, which put the subprime lender/servicer in the FDIC’s lap, she pushed hard to develop a template for how to do them, which then was ignored by the Administration (they did HAMP instead, an embarrassment which she refused from the outset to endorse).

The piece serves as an indictment of the banking industry toadies in the officialdom, namely the Treasury, Fed, and OCC. One priceless quote:

Capital and liquidity: whose problem?

Jon Daniellsson of the LSE has spotted something odd about the Basel III debate on capital levels…

DeLong Illustrates Why We Should Be Scared of Economists

Several readers sent me links to a Brad DeLong post which they took to be a rebuttal to a takedown I did of a recent Ezra Klein piece.

Since DeLong did not link to or mention my post, I doubt his piece had anything to do with mine. But his post is noteworthy for a completely different reason: it illustrates how economists have refused to learn much, if anything, from the crisis.

Satyajit Das: Default Semantics – Credit Default Swaps & Greece

Yves here. Despite the technical focus of this post, the underlying issue, of whether Greek CDS will pay out as protection buyers expected, is very important. As Das discussed in an earlier post, in the first real test of the CDS market (the Delphi bankruptcy in 2005), credit defaults swaps had required delivery of bonds to get the insurance payout on the contract . Since the volume of CDS on Delphi was over five times the amount of bonds outstanding, that would have meant a lot of people bought dud insurance. That was recognized to have the potential to have very bad outcomes for the market. So, on the fly, the International Swaps and Derivatives Association implemented “protocols” by which any two counterparties, by mutual consent, substitute cash settlement for physical delivery. In other words, they came up with a big fix that was nowhere in the contracts. Ain’t it nice to be a big financial player?

Efforts to extend Greek debt may require similar efforts at fixes, and if they aren’t fully effective, it could have a chilling effect on the CDS market (not that we think that is a bad outcome, mind you). But even with all the powers that be out to preserve the product and avoid roiling the markets, the conflicting objectives of various players may render that outcome not so easy to achieve.

By Satyajit Das, the 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)

The European Union’s linguistic gymnastics, redefining default as “restructuring” or “re-profiling” and the structure of any final deal on Greek debt has “real” implications for the arcane workings of the CDS market.

In the film Casablanca, Rick (Humphrey Bogart) tells Captain Renault (Claude Rains) that he came to the city because of his health, to take the waters. Informed that they are in the desert, Rick ironically replies that he was “misinformed”. Investors and banks that purchased Greek sovereign credit default swap (“CDS”) to protect themselves against the risk of default may find that they have been similarly “misinformed”.

Bhidé Cites “Rampant, Extensive Criminality” As Proof That Bank Reform Has Gone Down the Wrong Path

I though readers might welcome an antidote from the nonsense that bank industry touts like the Office of the Comptroller of the Currency’s John Walsh routinely puts forth.

I’ve known Amar Bhidé, who is now a professor at Tufts, for thirty years; we both worked on the Citibank account at McKinsey (although never on the same study). He’s long had a reputation for being incredibly smart and iconoclastic.

Amar enjoys annoying people by saying completely commonsensical things that are not acceptable and watching chaos ensue.

Mirabile Dictu! Central Bankers Getting Concerned About Bank Capital Levels Rather Late in the Reform Game

Something very peculiar is afoot. Well after the bank regulatory reform debate was supposedly settled, central bankers seem to be reopening that discussion. It’s puzzling because the very reason the banks won so decisively was that central bankers were not prepared to get all that tough with their charges.

I’m not clear what has led central bankers to get a bit of religion. Is it the spectacle of the Bank of England talking about breaking up the banks (they won’t get their way thanks to bank lobbyist working over the Independent Banking Commission, but no one doubted their sincerity)? Or the Swiss National Bank imposing 19% capital requirements, which as we discussed, is likely to lead to the investment banking are of UBS being domiciled elsewhere (assuming a country capable of bailing it out will have it)? Or perhaps it is central bankers being forced to recognize that their Plan A of extend and pretend and super low interest rates simply won’t lead banks getting to meaningfully higher capital levels when the staff continues to take egregious amounts out in compensation? Or have they realized how bad bank balance sheets are in the Eurozone and how tight the linkages still are among the major capital markets players, and they belatedly realize they need them to be much more shock resistant?

The bottom line is that various central bankers have taken the surprising step of insisting their banks meet more stringent requirements for the biggest banks than those originally planned to be to be included in Basel III. Per Bloomberg:

Goldman Sycophants of the World Unite! You Have Nothing to Lose but Your Virtually Non-Existent Reputations!

The Goldman defense against the Levin report is so late and so pathetic that it looks increasingly evident that the bank is simply hoping to cause confusion and muddy the waters rather than mount a frontal, fact-based rebuttal. Mind you, sniping and innuendo can prove reasonably effective if done persistently and loudly enough. The book Agnotology describes how Big Tobacco managed to sow doubt over decades of the link between smoking and lung cancer well after the medical evidence had gone from suggestive to compelling.

The first Goldman salvo was an Andrew Ross Sorkin piece on Monday which we deemed as unpersuasive. While it did point to an error in the Senate report, it failed to make a real dent the report’s findings, and most important, the notion that Goldman staffers, in particular Lloyd Blankfein, were pretty loose with the truth.

The most contested statement is the Blankfein denial that the firm had a “massive short” position; as Matt Taibbi points out today, the only way out on that one is to get into Clintonesque parsings of the word “massive”. Given the overwhelming evidence that Goldman intended to get out of its mortgage risk in late 2006 and its staff DID get the firm short in February 2007, then reversed that position in March to correctly catch a short term bounce (the market recovered from March to May, when it went into its free fall). And in the March-May period, it was still getting as much crap product out the door and lying to clients about its position in the deals, claiming its incentives were aligned when its effective short position in the deals meant the reverse, that it would profit if they tanked, which they did.

But focusing on the “massive short” issue is misdirection pure and simple.

Adulterous Failed Banker Fred Goodwin’s New Human Shield

Back in March, and courtesy of Naked Capitalism’s US locale, we arbed away Fred Goodwin’s superinjunction, which banned UK reporting of his affair with a junior director at RBS. After more challenges by the UK newspapers, the superinjunction has now been amended: it’s OK to identify Fred Goodwin as the failed banker with the wandering body part; but still not OK to identify his partner, who is referred to in the official documents by the code letters “VBN”.

Goldman Uses Wall Street’s Favorite Reporter to Make Unpersuasive Defense Against Levin Report

Last night, the Wall Street Journal reported that Goldman was going on the offensive against the Levin report:

Goldman Sachs Group Inc., trying to counter a Senate subcommittee report that is fueling investigations and suspicion of the firm, plans to accuse the subcommittee of drastically overstating Goldman’s bets against the housing market in 2007….

The subcommittee’s 639-page report in April denounced Goldman as an unusually strong example of wrongdoing by financial firms during the crisis. According to the report, Goldman systematically sought to profit from a “big short” against the housing market and betrayed clients by putting the firm’s own interests ahead of theirs.

Goldman initially said it disagreed “with many of the conclusions of the report,” though the company added that it takes “seriously the issues explored by the subcommittee.”

Tonight, Andrew Ross Sorkin of the New York Times offers what appears to be a preview of the Goldman defense. If this is the sort of thing Goldman plans to provide, it is not terribly convincing.

On the Shortcomings in US Nuclear Emergency Plans

I normally leave the nuke/Fukushima aftermath beat to George Washington, but furzy mouse sent me a link to this very straightforward and well done video by Arnie Gunderson of Fairewinds.

This evokes weird parallels to what we learned in the wake of Hurricane Katrina: it was obvious more needed to be done to protect public safety, but no one was willing to do it. And in visit to New Orleans over the Christmas holidays, I learned the levees have not been made higher as the Army Corps of Engineers recommended. All that happened was the breaks in the levees were patched.

Gunderson gives a straightforward account of theory v. probable practice in a nuclear accident:

Affordable Housing Groups Once Again Acting As Human Shields For Banksters

I’m not going to quote George Santayana tonight, as much as his famous saying verging on cliche fits. But will some people never learn?

Another useful cliche is that politics makes for odd bedfellows. But that notion is misapplied in a New York Times article tonight, which tries to convince readers that affordable housing advocates and mortgage financiers playing on the same team is a new development. Huh? Per the Times:

The weight of the mortgage crisis fell heavily on lower-income and minority communities…..That left consumer advocates and civil rights groups frequently at odds with bankers, mortgage lenders and their lobbyists during the debate over the financial regulation act last year, which aims to rein in the subprime mortgage excesses that inflated the housing bubble.

Now, as banking regulators are rewriting the rules for the mortgage market, unusual alliances have sprung up in opposition to tighter lending standards. Advocacy groups like the N.A.A.C.P. and the National Council of La Raza, a Latino civil rights organization, on the one hand, and the American Bankers Association on the other, are joining together to fight rules they say could make home loans less affordable for minority and working-class Americans…