November 21, 2012 § Leave a Comment
There really is not much to add beyond the excellent reporting provided by Reuters. Take 10 minutes out of your time to give this thing a gander.
September 20, 2012 § Leave a Comment
If this comes as a surprise, you haven’t been paying attention.
According to the discussion paper, about 80 percent of benchmarks were either compiled by associations or private entities. For survey-based benchmarks like Libor, the criteria for submitting data was not always objective and called for judgments about rates and prices, according to the discussion paper. Even in benchmarks that are based on actual transaction data, the compiling bodies retain discretion in producing the actual rates or prices.
“The risk of manipulation will be greater where participants in the process have both incentive and opportunity to submit inaccurate data or apply a methodology inaccurately,” the authors said in the paper. “Furthermore, where judgment is required in determining the data to be submitted, the problem is particularly acute.”
July 8, 2012 § Leave a Comment
By now, most folks have heard of Barclays’ LIBOR scandal and how the London-based firm submitted fake data to manipulate the benchmark instrument by which the international financial community derives its borrowing costs. However, to my knowledge, The Economist is the first publication to reference British regulatory bodies, while subtly questioning the role that they may have played in the period leading up to the great Credit Crunch of 2007/2008.
According to records, many of Barclays’ manipulations allegedly pared borrowing costs, which likely seemed like a great idea at the time for both the financial industry and government officials. Although we now know where cheap credit leads (cough…mortgage crisis…cough), low borrowing costs may have served as a confidence booster as financial markets reeled in 2007, thus alleviating public anger and potentially stymying an all-to0-certain demise. As The Economist notes,
The second type of LIBOR-rigging, which started in 2007 with the onset of the credit crunch, could also lead to litigation, but is ethically more complicated, because there was a “public good” of sorts involved. During the crisis, a high LIBOR submission was widely seen as a sign of financial weakness. Barclays lowered its submissions so that it could drop back into the pack of panel banks; it has released evidence that can be interpreted as an implicit nod from the Bank of England (and Whitehall mandarins) to do so. The central bank denies this, but at the time governments were rightly desperate to bolster confidence in banks and keep credit flowing. The suspicion is that at least some banks were submitting low LIBOR estimates with tacit permission from their regulators.
So, what is important about this? Well, a possible “collusion” of sorts which will likely prove helpful in turning Barclays’ (and possibly other’s) missteps into a boring story that many governments will surely shrug off in a month or two. For reference, does anyone remember the numerous “mark-to-model” scandals leading up and through the financial crisis? For my purpose, the most important thing to remember is that these scandals are, in fact, difficult to remember.
Basically, “mark-to-model” sprung from the belief that certain assets on a balance sheet should not be marked-to-market (meaning priced against similar or near-identical assets in the marketplace), but rather priced according to someone’s (something’s???) suggested value. Now, this “suggested” value can possibly be derived from empirical data, page A3 of the March 12, 1984 Wall Street Journal, or perhaps even a McDonald’s Monopoly pull-off-tab on a 32 oz. soda. Basically, the possibilities are endless.
With that being said, may I suggest you clear those spiderwebs from your memory and look back on an FT Alphaville article published in May 2008 quoting the Bank of England’s newfound affinity for mark-to-model accounting principles.
“[U]sing a mark-to-market approach to value illiquid securities could significantly exaggerate the scale of losses that financial institutions might ultimately incur. It will exaggerate to an even greater extent the potential damage to the real economy that these losses might inflict, since there are always winners and losers to financial contracts. This does not deny, however, the possibility of some adverse consequences for the real economy as a result of recent events — for example, due to a higher cost of capital for some borrowers.”
Now, is that rich or what? In American football, that would be noted as a “Hail Mary,” or perhaps a time-tested “There are no atheists in the foxholes” maneuver. In effect, the Bank of England began to eschew mark-to-market because…well- because pricing to market would have revealed those assets to be as awful as said assets, umm, actually were. Whoops.
Similarly, American regulatory bodies began looking beyond “fair value” accounting principles as U.S. investment banking assets began to turn sour. According to a Telegraph article published in September 2007,
[Lehman Brothers] ended the third quarter with $1.6bn of sub-investment grade mortgage securitisations on its books, including $230m worth of sub-prime loans.
[Lehman's Chief Financial Officer] Mr O’Meara stressed that 90pc of Lehman’s loans were classed on its balance sheet at either level one or two under FAS157, the financial accounting standard for mark-to-market and mark-to-model, meaning that the valuations now given to such loans are realistic.
Ah. Yes. Realistic. Prescience. Hindsight. Alas…
Additionally, let me note that the Financial Accounting Standards Board significantly eased reality-based accounting measures even AFTER (i) Lehman went bankrupt, (ii) Merrill and Bear were purchased, (iii) and a myriad of other investment banks damn-near suffocated under their incredibly burdensome balance sheets. Per Bloomberg,
Changes to fair-value, or mark-to-market accounting, approved by FASB today allow companies to use “significant” judgment in gauging prices of some investments on their books, including mortgage-backed securities. Analysts say the measure may reduce banks’ writedowns and boost net income. Firms could apply the changes to first-quarter results.
So – what is the point of my rambling? When times are tough, governments have a great interest in restoring a sense of calm, come hell or high water. Accounting fraud? So be it. Reporting false data? Where’s the hurt in dabbling. Lying to shareholders? Gotta break an egg to make an omelette.
With that said, am I explicitly stating that regulatory powers have been known to turn a blind eye when financial firms are creating the impression that things are better than they truly are? Yes. Is this the case with regards to the LIBOR scam? Yeah. Probably.
BoE Votes For Mark-To-Model [FT Alphaville]
May 18, 2012 § Leave a Comment
Happy Friday, and welcome to the new, new order.
“Federation by exception seems to me not only necessary to make sure we have a solid Economic and Monetary Union, but it might also fit with the very nature of Europe in the long run. I don’t think we will have a big (centralized) EU budget,” Trichet said in a speech before the Peterson Institute of International Economics here.
I’ll take “military aggression” in <5 years, Alex, for +€250BB.
April 30, 2012 § Leave a Comment
Watch as Ron Paul leaves Paul Krugman absolutely befuddled, for better or worse.
February 17, 2012 § Leave a Comment
Earlier this week, Reuters published an article on German banking which, I’m sure, left many Americans yearning for its insular model. According to the article, Germany “[...] has 2,000 banks, while Britain has just 405, Spain 415, Italy 785, Ireland 590 and France 1,147, according to European Central Bank statistics.” This large number, of course, has insulated the country’s commercial banking sector from many of the problems that enveloped and, in effect, brought about the “nationalization” of almost all large commercial and investment U.S. banks in 2008. Due to regulatory matters, many of these smaller banks are left to exclusively service the local community and, thus, not leverage capital 30-1 while purchasing tranche after tranche of poisoned MBS paper. Or, as Reuters more succinctly puts it:
The prevalence of municipally-owned savings and customer-owned cooperative banks, the microbreweries of the banking world, ensures a steady supply of business loans, reducing the likelihood of a credit crunch and helping to protect Germany’s coveted triple-A sovereign debt rating.
Unbelievably, this could have occurred in the U.S. If the federal government had not played matchmaker and backstopped the bleeding of our financial institutions, the smaller community-based banks would currently serve as our go-to commercial service providers.
The fact of the matter remains that we, the U.S. citizenry, would have been extremely hurt had more failures occurred à la Lehman. Yet, any rational person (see: those not filling government coffers or collecting from same) can realize that the certain implosion of Citi, Wachovia, and Bank of America would have created a tremendous opportunity for small, local banks to swoop in, purchase sound loans, and strengthen their services. Would there have been a long, lonely grace period where every financial institution and LLC or LP found itself extremely injured by this course of action? Certainly. Would the panic in the markets have been heightened for a prolonged period of time? Of course. Yet, we, as humans, remain highly adaptable to pain, suffering, and change, and the power of small markets would have eventually made things more palatable in the long run. In short, “high finance” would have been thrown back to the stone ages of 1960-1980, but the United States would have reacted in the most humane way possible: survival.
With that being said, in an ideal world, would it be advantageous for our regulatory powers to create a system based on local banking in order to mitigate the risks of another (eventual) financial “perfect storm?” Of course not. Germany’s banking system looks sweet and pretty from across the pond, and we idealize the situation by imagining Jimmy Stewart batting his eyelashes at us through the plexiglass; however, that system is equally dangerous. Many local German businesses are unable to seek competitive loan rates simply due to their geographic locations. The beauty of competitive markets precisely remains in the fact that other businesses can draw customers through sheer competition. When a government regulates too heavily and tries to impose “fairness,” the very idea of competition seizes to exist (beyond immediate boundaries).
Alas, the Reuters article inadvertently makes the case for economic cyclical asymmetry. Given a truly “free” marketplace, the sound loans held by the “big” financial institutions would have been swallowed whole by local markets, thus bringing about a sector similar to the German model. Eventually, other Citi/Wachovia/Bank of America models would have sprung, and a similar disaster to what we all experienced in 2008 certainly would occur. However, without the moral hazards that were effectively eschewed these past few years, how can one truly believe that our next blowup is more than a decade away?
Remarkably, the text above is not an argument for making the world more safe and sound, but rather for adhering to the regulatory system and economic model that the U.S. has promoted throughout the world for the last two centuries. It is unfortunate that our government sings the praises of cyclical markets while eschewing all opportunities to participate.
January 16, 2012 § Leave a Comment
It has been 38 years since France last imposed a balanced budget. Interestingly, 11 months have passed since President Sarkozy first suggested including a balanced budget amendment into the country’s constitution. As some readers may remember, Martine Aubry, the Socialist Party’s leader, deemed the potential measure “grotesque” and a “propagandistic smoke grenade.” Le sigh!
Well then, how did the country fare with Friday’s announcement that its credit rating would be downgraded by S&P to AA+ status? Sarkozy, forever poetic, took a page from Charles de Gaulle’s rallying book when stating, “This is a test and one we have to confront. We have to resist, to fight, we have to demonstrate our courage, to keep a cool head. We do not respond to a crisis of this magnitude with agitation, fits of anger and controversy[.]” Yes – he really did say that.
So, resistance from what? We do not know. S&P? Fiscal austerity? Responsible borrowing? Portugal? Spain? Ireland? Greece? The European Financial Stability Facility? France’s Socialist Party? Ah, yes. The latter, perhaps.
See, similar to the United States, France is stuck within an election year that has just become increasingly more ruthless given news of the downgrade. In recent history, Sarkozy has repeatedly referenced the country’s AAA status as a testament to his ability to lead. Unfortunately, he overlooked the fact that France recorded a deficit at 7.1% of GDP last year. Additionally, France owes quite a bit of its prosperity to neighboring countries that purchased its goods, services, and…gulp…debt throughout this past decade. Along with France’s downgrade came a similar blow to Austria’s rating, sapping the EU rescue fund’s guarantees from €451 billion to €271 billion. This decrease in funding will immediately put a strain on Ireland, Portugal, and most importantly Greece. Thus begins the downward spiral and impending collateral damage that will course its way through the EU. Well, that is of course unless the U.S. steps in to increase the rescue fund’s capabilities.
With that being said, I want you to close your eyes and imagine Romney and Obama standing at adjacent podiums in September, squaring off in true debate fashion. Let us pretend that both gentlemen are discussing the States’ inability to create austerity measures. Add bailout funding to France, Greece, and…well, the entire EU. Surely, you can now imagine a concoction not unlike molotov cocktails being thrown through the televisions/collective minds of middle-America. This ought to be fun.
The point being, of course, is that it’ll be a hard sell on both sides of the aisle. Mix that in with a strong Socialist Party showing in French polls, and you truly have a popcorn-worthy year filled with misinformation, anger, resentment, and unabashed nationalism. In short, American politics.
Well, at least we’ll finally figure out the resistance that Sarkozy so passionately referenced.
Europe Hit By Downgrades [WSJ]
The Great Debt-Break Swindle [Der Spiegel]
Election Season Is Heating Up In France [Jerusalem Post]
January 12, 2012 § Leave a Comment
The following is reprinted from Dealbreaker. Click HERE for the original piece.
Nikita Khrushchev, the former First Secretary of the Soviet Union, once remarked, “Berlin is the testicle of the West. When I want the West to scream, I squeeze on Berlin.” Given the EU’s current predicament, I find this statement prescient. But the people of Berlin could not care less about that predicament. In fact, most Berliners find Greece a bore and Portugal simply a destination for fast, easy women. So why am I so captivated by Chancellor Angela Merkel’s painful pandering and yet also sympathetic with Germany’s plight?
Germany has served as the antithesis to the rest of the EU’s character these last four years in fiscal policies, labor markets, free trade, and general stability. In my mind, Germany is basically being gangbanged by the rest of the EU, while paying handsomely for a reach-around. Yet it’s hard not to acknowledge that the nation’s surging economy has been made completely dependent on the needs and desires of other European nations to purchase exports while keeping said goods and services cheap and affordable. In fact, next to China, Germany is the largest international exporter. With that in mind, perhaps it’s understandable that many people I’ve spoken with don’t appreciate Merkel’s international importance. Many Berliners appear dumbfounded after learning that she can be found on page one of the NYT and WSJ almost weekly. As one gentleman here remarked, “She must make your newsstands much less desirable.”
Most Berliners don’t like Merkel, but can’t really say why. All the attacks I’ve heard are of the ad hominem variety, referring directly to her looks. Pulling from a cigarette, one Berliner told me, “Her fucking haircut is embarrassing for this city,” before collapsing on the bar in laughter.
Although the Germans tend to act indifferent towards their country’s newfound responsibility in keeping the EU from collapse, they admit that politics have completely ground to a halt these past few years. But to Germans, failure is not an option. No “bailout” is too big. There is no chance of Germany breaking away from the EU or printing its own currency. Basically, this is a blip in the EU’s (hopefully) long history. As a bar patron expressed, “Keep the tobacco rolling and the pilsner flowing. These … these are the things that keep Germany functioning.”
As Klaus Wowereit, the mayor of Berlin, stated this past year, “We want for Berlin to become richer while staying sexy.” One can’t help but agree.
November 24, 2011 § Leave a Comment
FT Alphaville penned an interesting article this morning regarding the state of investment banks and how medium to bulge brackets are reacting to increased public pressure on compensation, living within unchartered regulatory environments, and reacting with haste to immediate shifts in market activities.
According to the post, the following trends are noted.
I) a shift in compensation structures will result in reduced headcounts as opposed to reduced bonus pools;
II) commercial MBS markets are still reeling, and banks are having a difficult time securitizing this debt with a lack of demand and erratic regulatory initiatives;
III) commodities markets have been negatively affected in Q3 by EU sovereign debt woes and increased risks associated with pricing mechanisms. We should expect many redundancies within the commodity groups over the next two quarters;
IV) many hedge funds are seeking one or two prime brokers to limit complicated exposures to numerous entities.
Let’s work backwards. Regarding point IV, FT Alphaville properly notes that hedge funds are actually returning to the pre-Lehman bankruptcy days, when many funds operated with just one or two full-service prime brokerage firms. Either hedge funds want to cut back on their internal accounting work by taking a few cooks out of the kitchen, or they’re highly confident that specific prime brokerages are healthy enough to weather another panic in the financial markets. For this exercise, I choose the former.
With regards to point III, I believe that this is another short-term “correction” that will end up biting many i-banks in the ass over the next year. Whether we like it or not, commodities will be playing a rather large role through these next few years as the States and EU players begin crawling from monetary calamities and increased fear/lust/paranoia associated with the manufacturing and agricultural sectors. This is simply inevitable in my opinion.
On point II…well, there isn’t much to be said. The real estate markets, both commercial and residential, will continue to have a tough time through the foreseeable future. Home prices are still dipping by 2-5% YOY, and, although numerous corporations are repeatedly posting record profits, geographical market growth will continue to be hindered by high unemployment rates and tired municipal bond markets. In addition, and taking into account the three aforementioned problems that will continue to perplex corporate growth strategies, many CMB securities are difficult and risky to price right now simply due to regulatory/economic uncertainties. I have a feeling that the CMBS markets are going to continue to face slow growth through the first few months of 2013 (post election).
Finally, point I. Well, this is a huge problem, and one that I only see getting worse in the coming years (particularly for seasoned i-bank folk). With the great bonus backlash of 2009, compensation structures were tremendously altered. Performance-based bonuses were hindered, the incentive program was altered, and most banks significantly increased salaries. With a smaller bonus pool to report to shareholders and the public, much backlash was averted…right? Right? Anyone? However, with smaller profit margins and a rather large decrease in revenues, these shortcomings cannot be corrected by simply cutting back on bonuses. Instead, budgetary cutbacks will be made, heads will be cut, and blood will wash through the streets with all necessary corrections. Simply put, many folks will be deemed far too expensive to retain, teams will be stripped, and the pricing mechanism put in place for recruiting talent will be significantly altered for the next few years. In short, this is actually a difficult moment if you’re a supposed “big swinging dick” that’s been pigeon-holed into a tight sector these past few years.
However, looking over the list presented above, many of these problems could’ve likely been averted had the banks not made staffing/industry decisions with such haste. In turn, they’ll soon be making similar decisions in haste going forward for short-term gains with long-term losses. These losses will be seen with hedge funds placing all their eggs in one basket using a single or double prime brokerage, cutbacks in commodity focused groups prior to further volatility in pricing and competitiveness, and a progressively difficult compensation structure, thus limiting the ability to recruit and retain great swathes of talent.
In short, I feel that the financial services industry is doing itself a tremendous disfavor by reacting in haste to short-term challenges. I suppose we’ll see whether I’m right or wrong over the next two quarters.
The State Of Investment Banking [FT Alphaville]
November 8, 2011 § Leave a Comment
So it begins.
Fed Governor Daniel Tarullo gave a speech on Friday to the American Bar Association where he discussed international efforts on bank regulation. He reviewed the steps that have yet to be taken to complete the reforms of capital and liquidity standards and he discussed priorities for the financial regulation of cross-border firms. He also discussed Basel implementation, where he emphasized that the U.S. will not be implementing fully, because of its dependence on credit ratings.
Fed Governor Tarullo: U.S. Not Implementing All Basel Reforms [ABA Dodd-Frank Tracker]