Central Clearing: Solution or Problem?

Pushing more business onto central clearing systems is not the ultimate solution in the search for a more stable financial system. The question remains the same: Would the system be able to deal with a (near instantaneous) change of 20 or 30 pct of asset prices? Only then could one be reasonably sure that a market panic could not topple the financial system. But that would require a substantial increase in margin rates and a corresponding reduction in the amount of leverage available to all market participants.

M+A: Success ratio lower than at Russian Roulette

The statement may seem to be a bit extreme but anyone contemplating a Merger or Acquisition would do well to keep this warning in mind. All too often senior management falls in love with an idea or is egged on by advisers who are paid on completion only and therefore have no real stake in the ultimate success of the transaction.

Compensation gravy train: one train in the UK that you can rely on!

A woman has been awarded half a million pounds in a series of compensation payments after accusing four public sector employers of discrimination, unfair dismissal or sexual harassment (Daily Telegraph, 11 Nov 2010). While a disproportionate amount of claims are settled in the Public sector the financial sector is also vulnerable to the frightening rise in red tape and social engineering created with little regard to the realities of private business.

Patchy hiring to follow frenzy at European banks says Reuters

The real test of management will come when business volumes have declined so much that present staffing levels can no longer be justified. Those companies that have hired wisely and responsibly will have to do much less pruning than those that adhere to a irresponsible 'hire and fire' philosophy of human capital (mis)management.

Tulips anyone?

That comes to mind when reading about the frenzied trading in today's story stocks such as Facebook, Twitter and Linkedin. Which bank will it be that is left holding the bag financing a speculative hot-shot when the whole bubble bursts?

Deutsche Bank: rated most exposed by Japanese Regulator

While Deutsche Bank has performed admirably (at least on a comparative basis) during the financial Crash we kept being concerned about the slender margin of safety that is provided by the equity capital basis. DB may be less exposed to sovereign loans in the Eurozone and corporate loans may also be a lower part of its portfolio than in other institutions but that means that the bank is more exposed to financial assets and counter party credits. And the purchase of supposedly 'safe' businesses such as Deutsche Postbank and Oppenheim are by no means guaranteed to provide the high returns that management continues to aim for. News that Deutsche Bank is the lucky (?) owner of the most recent addition to the Las Vegas hotel scene does little to inspire confidence in the bank's risk management skills. Maybe the bank should pay its bonuses in the form of free hotel vouchers until the full extent of its exposure has been recouped.

UBS dress code memo

UBS was (and is?) known for fast-tracking officers of the Swiss Army Militia through its management ranks. We are not sure that the 'new UBS' (post SBC 'Merger') adheres to the same management principles. But given the fact that banks worldwide are inundated with more or less sensible regulations it is amazing that someone in the - still vast - bureaucracy of a large bank finds the time to devise such a detailed prescriptive paper. Rulebooks such as this tome certainly would not surprise anyone if it would be given to fresh recruits in an army barrack. I wonder what it does to promote morale at the workplace?

Deutsche Boerse: another Euro 450 mio written off on ISE

In 2007 the German Stock Exchange (Deutsche Boerse) acquired the International Stock Exchange ISE for more than Euro 2 billion. This write-off follows a provision of Euro 420 million in the last quarter of 2009. Acquisitions are minefields for the unwary and should only undertaken after careful analysis and after consulting advisers that give objective advice based on long financial and markets experience.

Secretive Banking Elite rules Trading in Derivatives?

A New York Times report highlights the lack of official supervision of trading in derivatives. In no industry would it be allowed that the dominating participants collude setting market rules without being subject to impartial outside regulation - be it from consumers or government authorities. When the market in OTC derivatives started it was a tiny cottage industry and supervision was unnecessary. Now the amounts involved are so enormous - multiples of the whole planet's GDP - that leaving the task of supervision to a few market insiders is no longer practical. One can only hope that the top officials of the financial firms concerned realize that - in the interest of society as well as their own - a new regulatory framework is urgently required. Putting the majority of the trading onto exchanges will alleviate the risks of a catastrophic market failure but this will in itself not be enough. The central clearing houses in turn will have to be made as secure as possible and only a substantial increase in margin that has to be posted by ALL market participants will ensure a safe market environment.

Goldman Sachs in controversy about CDS trade

We have for a long time called for more effective regulation of the market in credit derivatives. Therefore we are not surprised when details about Goldman's involvement in some controversial trades were disclosed by Carl Levin, chairman of the Senate permanent sub-committee on investigations.

Deutsche Bank set to leave Postbank alone after merger

We were never sure if the frugal customers of Deutsche Postbank really will make a large impact on Deutsche Bank's profitability. The headline makes us wonder even more. What is the point of buying the bank when it will be managed with such a light touch?

Extensive interpretation of race discrimination by UK courts

It is no secret that nationals from countries where their employer is domiciled often do - or at least appear to - get preferential treatment from their respective employers. This applies to banks and other financial institutions irrespective of their country of origin. This may well be considered unfair by some observers but could on the other hand be justified to some extent. How many Europeans working for a Japanese bank for example are fully conversant with the Japanese Language? And in the future we will have a tough time to find many seasoned professionals able to express themselves fluently in Mandarin, Russian or Arabic. So we noticed with quite some bewilderment that an English court can use legislation intended to fight race discrimination when sitting in judgement about an compensation claim by an English employee working for a French bank here in London. If the Gold Standard would have to be applied in every decision concerning promotion it would mean that in nearly every case the employee who loses out would have a case to sue. In addition, who determines which employee merits promotion more? Should every decision have to be submitted to a court or tribunal before it becomes effective? Politicians, the Courts and pressure groups all combine to make the UK a less efficient and less inviting place to locate a business and court cases such as this one are the worst possible advertisement for UK Plc.

Goldman to write down stake in CMC Markets

News that Goldma Sachs is to write down the value of its £140 million minority stake in CMC Markets is proof for the fact that even the most savvy acquirers sometimes succumb to hype and a good story. Over the years we have seen numerous instances when a gullible financial press has reported valuations of businesses about to be floated that were inspired more by the aspirations of the selling shareholders and their advisers rather than by thorough analysis of the underlying values of the business. Numerous academic studies have demonstrated that at best half of all acquisitions are successful and any firm contemplating strategic transactions would be well advised to consult advisers that are not driven by fees but have the interest of the client at heart.

Some simple rules for banking reform - and no need for a PhD either!

One aspect of banking reform that has been completely neglected would be the requirement to match the maturities of assets and liabilities more closely. While 100 pct will never be practical there should be tight guidelines. Bands of maturities on both sides of the balance sheet should be closely matched to about 90 per cent. Large banks, and in particular trading firms, should not be able to roll a mountain of short term debt to finance highly speculative positions and hope for the best - or the next taxpayer-funded bailout. The huge interbank market is also ripe for more regulation. There simply is no need for a fragile house of cards of interbank positions on which to build a proper lending business. A small amount of interbank lending is always required to smooth positions but every bank should mostly rely on deposits from its own customers (and matched as to liquidity). These rules are simple to monitor, no PHD or even MBA is needed, just sound people with common sense and a health work ethic (in contrast to a bonus ethic)

Regulatory costs out of control

A quick look at numbers released by Brewin Dolphin, a wealth manager in the UK, confirms our fears that regulatory costs have exploded well out of control and that the supposed beneficiary, the ordinary investor and saver, has very little to show for it. At Brewin regulatory costs have now reached 6 percent of turnover, totalling around £15 million. When put in relation to pre-tax profits of £31.4 million or assets under management/advice of £23.2 billion one can see that bureaucracy is just another tax where most of the proceeds go towards paying the running costs of the self-serving bureaucracy (4000 paper-pushers by now and rising rapidly).

FSA vetting procedures - deepening bureaucratic morass

An interesting side-effect of the FSA's vetting procedures for senior banking executives is highlighted in the Financial Times: the widely-applauded push for more female board members may be hindered as the vetting procedures tend to favor experienced males, especially those with an accounting or audit background. As it is difficult to find many senior women with that kind of background companies may struggle to fill vacancies with women candidates. In addition, candidates may be deterred from putting themselves forward and submit themselves to the FSA vetting regime. We are not really of the opinion that favoring women during a search is the right way to go - just the other day an old colleague from Goldman Sachs mentioned to me that any woman aspiring for a more senior role there must make a hard choice between domestic and professional life with any one going to pursue her career in earnest likely to have the backing of a house husband. But on a wider front one has to ask why would any experienced professional want to undergo the humiliation of being 'vetted' by paper-pushers at the FSA that have achieved less and are less capable? Any person worth his salt in Moscow, Tokyo, Hong Kong or New York is well advised to stay where he/she is and say 'thanks but no thanks' to any job offer here in London. And that is without even mentioning the weather, taxes or public transport.

No improvement in pay practices at banks - study

An study commissioned by the Council of Institutional Investors comes to the conclusion that changes to pay practices at major banks in the USA have lead to a deterioration rather than the intended improvement in incentives.

Lehman bankruptcy administration costs reach $1 billion mark

Regulators worldwide can be congratulated for contributing so generously to the fortunes of lawyers, accountants and assorted advisers who reap this windfall at the expense of savers and investors. A special thank you must be reserved for Hank Paulson was instrumental in orchestrating this signature disaster during the Credit Crunch.

Kafka alive and well in US Government

The absurd consequences of the obsession with fighting symptoms rather than causes and increasing the reach of government and civil servants at all costs is demonstrated by news (Wall Street Journal, 20 Nov 2010) that major US banks are intimidated enough to refuse to conduct business with a large number of foreign embassies in the USA. In countries such as the UK opening a bank account is a major burden for consumers and achieves no demonstrable benefit in terms of fighting crime or terrorism. The costs of complying with regulations that become more complicated by the day is immense, not only in direct costs related to the governmental enforcement agencies but also in terms of additional staffing in financial service firms.

Troubled Borrowers should not be treated too leniently

One of my favourite City Commentators, Anthony Hilton, writes in his Evening Standard column that it would be in EMI's interest that Terra Firma and Citigroup 'talk' to resolve their dispute. But all too often these negotiations are a win-win situation for the over-leveraged borrowers. Any concession by the lender is in effect a gift as the really logical situation would be a write-off of the equity and the transfer of ownership to the lenders. This would also be beneficial from a societal point of view as it would redistribute wealth in a more equitable way, preventing capitalism from becoming a one-way bet for the borrowers. 

From a business point of view, banks must look after their profits, this benefits not only their shareholders but also taxpayers as any capital cushion they build up will also reduce the amount of any future bailout that may be required.

Staff Performance Reviews under Fire

A recent article in the Wall Street Journal takes aim at staff performance reviews. Temple Associates has long argued that the present performance review system is a ritual and platform for political power plays - especially in large, bureaucratic organisations. In addition, the secretive and arbitrary way that bonuses are awarded does little to alleviate this problem. While well-intentioned, making awards too dependent on subjective opinions (even worse on a 360 degree basis) would often turn out to be ludicrously discriminative if it would be brought out into the open - or even subjected to legal test. While maligned by regulators making performance-based pay dependent on numbers would be a more objective and less controversial way of establishing fairness. In addition, company-wide bonus schemes on an equal percentage basis could be administered for all employees. This would allow to incentivise those employees who work in areas where performance cannot be assessed based on numbers alone.

Pitfalls of Acquisitions

The 2005 takeover of Eurohypo by Commerzbank is just another example in a long list of acquisitions that led to disastrous consequences for the acquiring party. While not many people could have predicted the Credit Crunch at that time it confirms the conclusion of many studies that say that at least half of all acquisitions are not successful. Utmost due diligence is therefore the order of the day when undertaking M+A projects. Unfortunately, too many deals are driven by egos - especially those of CEO's who brush aside all concerns - quite often even those voiced by their internal strategy and planning departments.

Bankers need to find bonus accord?

That seems to be the opinion of Mark Kleinman (FT). But quite apart from the legal aspect of companies coming together on a sensitive subject I would be sceptical about the success chances for any such accord. As long as economic pressures lead to competition for the services of quality professionals there will be upward pressure on the compensation packages for those most in demand. Salaries (and employment numbers) among the run-of-the-mill employees may well be under downward pressure at the same time but top performers should remain well bid for. This trend is exacerbated by the fact that alternative investment managers in the hedge fund and private equity sectors are continuing to benefit from an extremely lax regulatory environment that gives them a leg-up when competing for staff with banks, traditional fund managers as well as industry and commerce in general.

How to protect bankers from themselves

The story of then 34-year old Moses Stern who - despite having no experience in the real estate business - obtained a $126 million loan from Citigroup to buy a chain of shopping malls demonstrates that bank regulations are needed to protect bankers from themselves. Bank Lending must be made subject to much stricter regulation with respect to loan-to-value limits and the quality and amount of underlying collateral. If there can be margin rules for share buying there is no reason that similar rules cannot be applied to lending - especially in property lending which seems to be to bankers what drugs are to drug addicts. Property lending appears to be easy as there are no tricky judgements to be made about the value of a business and bankers can push up the lending volume quite easily.

BBVA acquires 24.9 % stake in Turkey's Garanti Bank

While the price may appear to be high compared to still depressed share prices in most banks it is not a dramatic premium compared to prices paid for banks in emerging markets during the pre-crunch euphoria when they were way above intrinsic value.

Basel III - 'Dangerous Nonsense' - discriminates against small banks

A report by the respected Austrian lawyer Gerhard Wildmoser comes to the conclusion that the new Basel III regulations favor big banks at the expense of smaller - and often much more conservative - banks. The key causes of the Credit Crunch - the careless attitude to customer's deposits, the purchase of questionable assets and the reliance on the state as a lender of last resort - would not even be addressed by the new regulations. In my view, the unelected bureaucrats and lobbying dominated by 'Too-big-to-fail' banks and their assorted 'research institutions' is on course to score another magnificent own-goal at the expense of taxpayers and citizens in general.

UBS wants to take more risks says CEO Gruebel

Oswald Gruebel, himself a trader by background, says that UBS wants to take more risk in order to increase profits from Investment Banking. It remains to be seen how that strategy blends with the regulatory desire to reduce proprietary trading in banking. But risk in investment banking does not only mean positions (punts) taken by traders in bonds, equities, forex and commodities. It can also mean higher risk by lending (for higher margins) in commercial and investment banking. As such it is often disguised (even from the bank's management) and potentially more dangerous for that reason. But all banking is to some extent depending on taking (intelligent) risk and the change in strategy therefore is not necessarily an imprudent one. Execution and attention to detail - as always - is the key. On the other hand one would think that a truly global franchise such as UBS should make enough money from client-related business alone so that excessive risk taking is no longer required for the achievement of a satisfactory return on capital.

JP Morgan to acquire Brazilian Hedge Fund

It is not necessarily a logical consequence that banks that now are required by regulators to scale down their proprietary activities have to compensate for this by buying into hedge funds. Hopefully they do so if they expect to make a profit out of their stakes. But apart from the hefty price tags hedge fund businesses still attract, we think that adding to in-house asset management offerings runs counter to the tendency towards using 'open architecture' in asset management - and in particular with respect to the product selection for a bank's high net-worth and other retail clients.

Scandal of Lehman Bankruptcy Costs

The spiralling costs of related to the resolution of the 2008 Lehman bankruptcy can only be described as scandalous. Rather than worrying about how to make life for the banking and investing industry more difficult the regulators (in most countries) should pay attention to this little understood corner of the financial world. Similar abuse goes unchecked in ordinary bankruptcies as well were suppliers or creditors get short shrift from a dysfunctional and inbred community of 'bankruptcy professionals'. Assuming the average overall cost of a professional should be around $300,000 the costs that have been run up in the Lehman case so far ($982 million) would pay for the services of an army of just under 2000 professionals working exclusively on this case during the past 2 years. Any money squandered during this process leave investors worldwide out of pocket and therefore this is no game where no one is losing out. Where are legislators, regulators, the media or the corporate governance tribes to check the efficacy of the endless hours billed or the rates charged?

UBS - enterprise culture blamed for credit desaster

The just published report on the inquiry of events during the 2007-2009 credit crunch puts the blame for UBS' woes at the door of a lack in an appropriate enterprise culture.We are in the privileged position that we do not only work as recruitment consultants to a number of financial service firms but as business advisers we are also offering a more 'holistic' service that does not end with putting 'bums on seats'. Our own direct experience in the markets has taught us the importance not just of individual brilliance but of an enterprise culture that is not solely focused on maximising profit for the firm and/or the individual. As the products the industry offers are intangible it is all too easy to forget that pride in the work/service performed and customer satisfaction should be primary motivators. Profits should be a consequence and not the sole motivator of those working in banks, brokerage and money management businesses.

Frankfurt no serious competition for London

There hangs a question mark above London's position as the leading global financial centre. Too much regulation and taxation may well lead to a draining away of business to other centres. But one look at the way the German government handles the banking sector makes it clear that the competition is unlikely to come from European cities. News that the German coalition government is about to slowly strangle Commerzbank, one of the few major financial players left in Germany, ensures that Frankfurt will remain a regional and national financial player (at best).

Buyer's remorse over signing-on payments

I always felt that the mad scramble to sign up investment advisers or private bankers and pay them massive up-front bonuses in the hope that they will be able to convince their clients to follow them to the new employer smacked of desperation. So a report in the  Wall Street Journal ('Signing bonuses haunt Wall Street') comes as no surprise to us. In addition, this hiring practice leaves open the question whether lavish inducements are suited to ensure that the advisers will have their customer's best interests at heart when helping them with their investments.

Joaquin Almunia - what does he know about banking?

The current EU commissioner in charge of competition policy, Joaquin Almunia, is just another typical example of the career politician who more and more dominates the life of ordinary citizens in our 'democracies'. He never earned his living outside the sheltered confines of government bureaucracies and owes his whole existence to the party hierarchy in Spain. How someone with his skill-set can be expected to be in charge of a department that requires at least some basic understanding and real-life experience of business and banking is beyond me. Admittedly, things are not much better in other parts of the world but that is little consolation for Europeans who have to live with the consequences of misguided policies that ultimately threaten the viability of their economies.

Goldman versus Matt Taibbi - PR Battle looms

Given the history of the stormy relationship between Goldman Sachs and Matt Taibbi it will be interesting to see who wins the public relations battle during the next few months. Goldman has just launched a major PR campaign to improve its public image while Taibbi's new book 'Griftopia' about how he thinks that Wall Street really works is going to be published in November. With respect to Goldman we would advise the company to spend less money on expensive ads but devote more thought on how to avoid getting business and politics mixed up in the future.

More pessimism about outlook for investment banking

Andy Kessler is always interesting to read. In his latest piece in the Wall Street Journal he makes a pessimistic prognosis for the investment banking industry. He thinks that current - and prospective - levels of business activity cannot support the present number of traders, salespeople and deal makers. While we think there is a chance that emerging markets and markets in Eastern Europe and Asia will to a certain extent help to reduce this pressure on the industry it will at best help to keep levels of employment and activity at similar levels to what they are now.

A distorted view of the banking crisis

The standard of public discourse in the United States reaches a new low when respected commentators can argue that the main culprits in the crisis that hit the US financial system were the politicians in Washington. If one wants to one can argue that EVERY citizen and institution was culpable, be they lenders, borrowers, investors, voters etc. But to pin the majority of the blame on Washington goes to far. No one ordered Dick Fuld to manage the affairs of Lehman Brothers the way he did, nor can this argument be an excuse for the egregious failure of Bear Stearns' management to see the danger signs flashing all around them - while they were happy to spend time on the golf course or playing bridge.

Should Malta and Latvia merge?

The way legislation (if you want to call it that) goes in the EU, the merger of Malta and Latvia may not be so nonsensical as it may sound at first. We got the idea from Damian Reece who writes for the Daily Telegraph. In a recent article he said that Malta and Latvia have more control over the future of the financial services industry in the United Kingdom as the British government or its citizens. Cementing this relationship would in our opinion be a sensible step to establish a new - transnational - financial powerhouse in Europe. Assuming that more and more professionals would leave the field to the EU bureaucrats and civil servants who more and more run European banks they might find easy pickings. If the two countries manage to keep their two votes in the EU institutions it should be easy to build (bribe?) a coalition that gives them free reign.

Staff could sue if discriminated by customers

If anyone has hoped that a change in government would reduce the regulatory burden in the UK the new Equality Act that comes into force on October 1 will give them a crude awakening. The Act will give workers the right to seek compensation from employers who fail to take reasonable steps to protect them from any form of discrimination by a third party. This fits in perfectly with the news that the number of claims lodged with employment tribunals in the period 2009/10 has rocketed by 56 per cent to 236,100. Lawyers must lick their fingers when they put two and two together and get ready for the next wave of discrimination claims against hapless employers. As will experts in relocation away from these green shores.

How to define Prop Trading

All market professionals know what proprietary trading positions are when they see one. But one has to doubt if regulators - or the politicians pulling their strings - are so perceptive. They also will have to write regulations that are as watertight as possible and define the term so that it fits as many conceivable real-life situations as possible. But consider this: any boring retail bank has by necessity some mismatch between the maturity of assets and liabilities. One could say that this mismatch - and even more the changes to it as market conditions/expectations evolve - constitutes proprietary trading. The lesson is that the elimination of proprietary trading will not by itself solve the problems that are inherent in a banking system that is based on the (false) premise that there will never be market panics and/or that the authorities can always contain them at no or little cost to the taxpayer.

Investment Banking Jobs in Danger?

When the prominent banking analyst Meredith Whitney predicts substantial job cuts in the investment banking industry it pays to listen. After all, in 2007 she had correctly predicted that banks would be under severe pressure when she highlighted that Citigroup was under capitalized. As we at Temple Associates work as business as well as recruitment consultants for financial services firms we look at this chilling news from two angles. Naturally we were pleased with the brisk demand for staff that we have seen during the past 6 - 12 months. As business advisers, however,  we were always sceptical about firms that hired staff 'by the dozen' and tried to expand at breakneck speed. Many of the worst perpetrators are no longer with us as their businesses lacked the cohesive culture that would have allowed them to navigate the dry patches that any investment banking business invariably goes through from time to time. More often than not the salaries that were handed out in order to entice experienced professionals to join were higher than necessary and burdened the business with excessive fixed costs.

No one helps Bank analyst Bove in hour of need

We are not able to confirm details in today's New York Times article about the lack of support for Dick Bove. BankAtlantic, a Florida bank, sued him, accusing him of defamation after he wrote a report about the banking industry in July 2008, just as the financial crisis was starting to boil over. The bank contended that the report falsely suggested that the institution was in trouble.
But if his claim that several associations that represent stock analysts or the securities industry declined his requests to help him pay his legal bills it leaves a sour taste in the mouth - to say the least. What use are the Securities Industry and Financial Markets Association, the New York Society of Security Analysts and the CFA Institute if they decline to make a stand for independent investment research. To cap it all, they declined to comment when approached by the New York Times. Even worse - the investment bank Ladenburg Thalmann, his then employer, chose to settle its end of the case by paying BankAtlantic $350,000, without admitting to any wrongdoing, and leaving Mr. Bove to defend himself.  We are glad to report that Bove won his court case against the Bank but is still left with legal bills totalling $800,000. The stakes in a case like this are high as any successful lawsuit against an analyst would deter critical analyst comments in the future and stifle independent research.

Investment Banking: tough to make it pay

A quick glance at the stock price history of Deutsche Bank illustrates how difficult it is to make sustainable profits out of investment banking. Since the early 1990s the share price has only made moderate gains. So news that the bank may soon ask shareholders to support a Euro 9.8 billion capital raising leads one to ask how the management will create value to justify this capital increase. In retrospect it appears that even a leading position in investment banking does not guarantee the profits that management has repeatedly promised its shareholders. We also foresee problems in making the planned acquisition of Deutsche Postbank a very profitable investment as most of its 5 million customers belong to the less-affluent parts of society or keep their account at the bank only in order to facilitate simple payment transactions.

FSA fines Goldman Sachs $31 million

The way the FSA arrives at the amount of fines levied is shrouded in mystery. Only dictatorships like the good old USSR and the like were allowed to operate in this fashion. London as a place to do business is on a very slippery slope and it should be remembered that its pre-eminence has only been achieved over the past 20 or so years. Before that finance was a cottage industry at best. People are highly mobile, communication is much better than 20 years ago and decamping to friendlier shores should not be too difficult - especially when half the top professionals are foreigners anyway. The backoffice can safely be handled in places like India.

Masters of the Universe: Memento Mori!

The report of a senior derivatives trader jumping to his death after snorting cocaine should be a warning sign to the 'Masters of the Universe' that fill the ranks of banks and investing institutions. Given the extraordinary sums that many of them earn it is easy for them to lose touch with reality and believe in their superiority while at the same time forgetting that their good fortune is partly only  due to the confluence of several factors that contributed to the enormous increase in the profitability of the sector during the past 20 years. Just to put it in perspective: in the late 1970s the average equity stake of Goldman Sachs partner was still less than $ 1 million! But this did not hinder them to give an excellent professional service to their clients and to enjoy a social prestige on a par with the best professionals in medicine, law or any other profession.

Barnier: get out of Europe, fast!

That is the only message any financial service professional with a brain between his ears will get when he reads the interview that the EU's financial service supremo, Monsieur Barnier, has given to the Handelsblatt. In it he claims that 'bankers' have acted "irresponsibly, amorally and unethically". We would be the first to admit that not all was (is) well in the financial services industry but to have the senior EU bureaucrat uttering a wholesale condemnation of all those who are working in the industry can only be called scandalous. That such a statement comes from an apparatschik who is in fact responsible to no one except the puppet masters among the ruling political clique in Europe, and especially France (do we want to remind you of Sarkozy who reminds us more of more of Louis de Funes in his heyday?), underlines the fact that the future of the financial services industry in Europe will one day be a copy of the common agricultural policy.

Banking Reform: Tinkering leads to bureaucratic monster

Reports that the BIS wants to collect more data about risk exposures in banks confirms our argument that current efforts to reform the banking system lead to more and more intrusive micro-management (and second-guessing) of decision-making in banks. The key problem with the banking system today is that there is simply no safeguard against a bank run. The system relies on the illusion that short-term deposits can be used to finance longer-term assets. Until a solution to this problem is found no amount of financial regulation will be sufficient to make the system 100 per cent safe and able to survive a panic without reliance on government support.

Sauve qui peut!

Today's news is dominated by triumphalist announcements by the bureaucratic supremos that want to control (strangle?) the financial markets in the EU. Michael Barnier and Jean-Claude Trichet are both products of the statist mindset that is drilled into the brains of the French bureaucrat (or 'Elite' as they call tend to call themselves). But after checking again we found not the slightest shred of evidence that either of them has ever earned a single penny by providing useful services to their fellow citizens. They spent their whole lives at the expense of the taxpayer and both enjoy wielding unprecedented power in artificial bureaucracies that allow them to issue edicts without any democratic restraint. If Britain wants to preserve any chance to keep its position as a world-class financial center it has seriousely to consider to opt out of regulation that is imposed from outside. The alternative is the acceleration of the migration of qualified experts to friendlier climates like Switzerland and further away.

US sanctions akin to tolls exacted by robber barons

It is highly problematic that banks based in other countries are forced (blackmailed?) to obey the politically-inspired wishes of narrow cliques and lobbies in the 'land of the free'. Sanctions against North Korea or Sudan may well be justified in the eyes of some or even a majority but that should not give the US the right to unilaterally decide for other countries were the governments - and even less so the citizens - have had no say in the matter. How would the US react if a European country imposes sanctions/penalties on IBM or Apple because their products are sold in a country that has been put on a sanction list by that country? Due to the technicalities of the international payment system banks are by definition involved in some US business (however tenuously) when they deal in US dollars, but this fig leaf should not be accepted without forceful resistance by the governments of other countries whose banks are penalised. This type of penalty is much more like the tolls exacted by robber barons in the Middle Ages.

HSH Nordbank: Management plays power games

The infighting  between the CEO of HSH Nordbank and former senior managers could be called absurd if it would not be a symptom of a serious neglect of the real problems the bank faces. Claims and counterclaims revolve around the possibility that the CEO entrapped another board member for having disclosed a confidential management document to the press. Time and again senior management becomes too self-centered and the companies that are entrusted to their care suffer for it. Recent examples illustrate the point: Bear Stearns, Lehman, Royal Bank of Scotland all ran aground while autocratic managers were at the helm.

FACTA: Will the EU stop US power grab?

As the implementation of the Foreign Account Tax Compliance Act by the US authorities draws nearer, it will be interesting to see how the usually toothless EU bureaucrats react to this one-sided power grab. We see no reason to accept the US intention to extend the reach of their tax law beyond the US borders. If the IRS wishes to have full control over the assets of US citizens it should set up a system of rigorous border controls and monitor all transfers of asset into and out of the country. Alternatively, the US can impose withholding taxes if it so wishes but as the country is dependent on foreign investors supporting the profligate spending by government and consumers alike it would only hurt its own interests by doing so.

A Stalinist Approach to Banking

The head of Bafin, the German banking regulator, boasts that his staff will become 'permanent guests' in all major banking institutions. This confirms our long-standing theory that only ever-closer control of all aspects of banking will satisfy the politicians' urge to supervise the business and make it conform to their wishes. Every rule needs interpretation which means another rule which leads to another rule and so on. As no one wants to make a mistake each decision will have to be cleared with a supervisor. At the end there will be a stalinist system of one 'commissar' standing behind each front line banker and the banking system will be completely ossified. 

Cash bonuses reduce risk - Study

Banking regulators all over the world think that it will help to reduce the risk of the banking system if they require a larger portion of total compensation to be paid in the form of equity. A recent study refutes this notion and tries to demonstrate that cash incentives are better suited to achieve a less risky banking system.

Musings of a Hedge Fund Manager

If ever you thought that the books on management you read at University were full of obvious platitudes you have seen nothing yet. Ray Dalio, the founder of Bridgewater, may have been successful - being in the right place at the right time and starting a money management business at the bottom of the market in 1975 must have helped - but I wonder how he could have found it useful to concoct a philosophy or life and business that just is a very poor copy of what one can find in countless books about self-improvement that are so popular in America.

Bank Capital should be 13 pct - Basel Committee

The problem with defining the appropriate level of capital that banks should hold on their balance sheet is that in a general panic no amount of capital is adequate to deal with a bank run. For many decades banks could get by with wafer-thin margins of safety as generally confidence in the integrity of the banking system was high. Tinkering with capital requirements may be but one step in the right direction. Banking reform needs additional measures to be successful.

Image Campaigns - do they make sense for Banks?

Both Credit Suisse and UBS have recently launched advertising campaigns that are aimed to bolster their brand image. But does the sponsoring of Formula One really help UBS to reclaim lost ground with the high networth clientele that must surely be the main target for its marketing efforts? 
Image Campaigns may well have a role to play for banks that are active in the mass market but for banks that are mainly involved in the institutional or high networth market a more focused approach must be the preferred route. 

 
 

Who should regulators be accountable to?

The complaint by financial sector trade bodies about proposed changes to the UK's regulatory system raises the interesting question about the accountability - or lack thereof - of the financial regulators.  UK banks fear that the scrapping of the Financial Services Authority (FSA) will leave power in the hands of a small, unelected group. But can one really say that the FSA was accountable just because it was required to hold an annual public meeting and had to hold regular meetings with senior industry managers through its so-called Practioners' Panel? We wonder what the outcome of the Credit Crunch would have been if the regulators would have been subject to full democratic control during the past few years. If anything the reaction to the crisis would have been less decisive and therefore less effective. Democratic control would better be applied during the stage in the legislative process when the framework for the regulatory regime is designed and there is time for more - and more broadly based - discussion between all parties involved. That would allow the voice of taxpayers and consumers to have more weight in the ultimate outcome.

Pay rules: Bureaucratic nightmare in the making?

A report by PriceWaterhouse raises the spectre that new pay regulations could be applied to thousands of financial services firms. While the usual sham 'consultations' are conducted by the FSA we can confidently predict that by implementing new pay regulations beyond the small group of systemically important banks the dead hand of government would certainly make one mighty step towards killing the goose that lays the golden (tax) eggs in the City of London.
The average employee has zero influence on the overall risk profile and financial performance of his employer. A small circle of top managers is wholly responsible for the success of any enterprise in our system of corporate governance and any major delay in paying the much-needed pay-checks to staff further down the rung will only massively demotivate staff - and in many cases make them willing to consider a move to friendlier shores.

Verdict on Dood-Frank bank reforms

This quote (Liam Halligan, Sunday Telegraph, 25 July 2010) says it beautifully:

"Based on sound-thinking courageous judgement, the Glass-Steagall legislation was only 17 pages long. Packed with wheezes and loop-holes, Dodd-Frank runs to 2,319 pages. Enough said"

Limits to Vulture Funds?

A report about buyers of under-performing mortgages trying to strong-arm borrowers points to the problems that can be created by unfettered trading in loans. What treatment can borrowers - be they individuals, companies or countries - expect in a financial environment where every loan is for sale? Borrowers select lenders not only on price but also on reputation. They want to know who they deal with and do not expect the representative of an aggressive vulture fund to knock on their door if they struggle to meet repayment terms. 

Goldman cannot separate Derivative Profits

from its profits in cash securities. According to Bloomberg Goldman Sachs has refused to disclose how much it makes trading derivatives to the Financial Crisis Inquiry Commission. Goldman CFO David Viniar stated that the firm 'has no way of separating out its derivatives data from trading in cash securities'.
We can only assume that some information got lost on the way from the FCIC to the reporter as we can not imagine that at a time when computing power is so abundant it would not be possible to separate the profitability by product - down to the P&L of each individual transaction.

Re-Recruit your team every day

In this interview the CEO of The Limited makes the interesting point that 'her job is to re-recruit her associates every day and give them a reason to choose to work for us and for her as opposed to anybody else'. Definitely a good point, - especially in view of the fact that so many relationships between boss and employee are adversarial rather than cooperative.

Lagarde: Stress tests will show EU banks healthy

Strange that she seems to know what the tests that are currently performed will look like.

Germany: Compliance Madness

It is well-known, that thanks to Karl Marx Germany 'gifted' Communism to the World. He may not have been the sole inventor of this creed but he certainly perfected a system that brought unhappiness to millions of people in its wake. Germany may not be considered to be at the cutting edge of the development of financial markets but the unreformed bureaucracy that holds the country in its grip certainly makes a meal of it when it comes to throw an -ever-tightening net of useless and costly controls over the activity of German citizens. Officialdom still lives in Kaiser's times when a citizen could truly be called an 'Untertan'. Little does it matter that the problems of German banks are mostly due to political interference in the Landesbank system that should have been abolished decades ago. Little does it matter that managements of certain private banks were making serious mistakes (and have in some cases been rewarded with princely retirement packages). But the bureaucrat's reaction is typical in as much as statism calls for ever-tighter prescriptive controls in order to 'improve' the system. Logic dictates that the end of this process is an ossified system that will at some stage resemble Cuba, North Korea or the former Soviet Union. Every step will be controlled, have to be submitted to approval by a 'commissar'. That the 'Elites' of Europe at this moment congratulate themselves (the utterly silly finance minister of France was seen to clap her hands at the signing ceremony) to have initiated another scheme to reward to undeserving (called EU 'Safety Net') is fitting testimony to the utter contempt they hold the subjects in their member states. It is offers little consolation that the situation is hardly any better in most other countries as governements seem to be in a concerted arms race to more control rather than proper reform of their economic and political systems. Unfortunately, the dominating system of 'pseudo-democracy' will allow the creation of more and more bad legislation. Only a system of direct democracy which we advocate will allow citizens to reign in unaccountable politicians and bureaucrats.

Banking: Maturity Mismatch continues

Reports about increasing levels of stress in bank funding should surprise no one. One of the key lessons - if not THE key lesson - of the Credit Crunch should have been that the Banking System was in need of a complete overhaul of the liability structure. Financing long-term assets and loans with shorter-dated liabilities may have worked in the days of sedate financial and economic structures in the period after WWII up to the 1980s. But an existence relying on hand-to-mouth feeding of liquidity from deposits that are for periods of days, weeks or even months was - and is - a recipe for disaster. Money Market Funds feed the illusion of liquidity on the asset side and are a further contributing factor to this asset-liability mismatch as is the enormous amount of commercial paper rolled over by companies as well as financial institutions. 

FSA behaves like a traffic warden

The FSA is a enough of a burden for the ordinary saver in this country. More than 4000 bureaucrats are well paid to push around paper and a corresponding army euphemistically called 'compliance officer' has to be fed on the other side of the fence . That those prosecuted face an inquisitorial regime becomes obvious from this case: like the victim of the traffic warden who faces extortionate costs if he does not immediately pay up the FSA's victims face the insult that they have to pay for ludicrously high prosecution 'costs' when the bureaucrats in their secure job (and without any proper accountability) are already paid their safe salaries by the taxpayer/saver. As in all legal cases in this country there are no proper checks on fee gauging as in other countries where the lawyer's fees are set in strict accordance to the amount of the claim.

Bank Chief: Savers should lose in bank failure

We tend to agree with Peter Sands, chief executive of Standard Chartered, who said "that people with savings above any sum guaranteed by law — £50,000 in the UK — should be hit with other providers of capital if a bank fails" (The Times). But we think that a small - but important - group that was left out in the proposals were the senior executives of the banks. Having their money at stake did not stop senior management of Bear Stearns and Lehman to run their companies into the ground but in this post-crunch area it would certainly be a useful addition to the armoury of regulators if managements would have more at stake than just their jobs in case a bank should get into trouble. Given the vast amounts of bonuses, share options and other perks the compensation beyond a reasonable basic salary should be mandatorily vested during their employment and for a minimum period after they leave the bank.

Dubai debt settlement leaves sour taste

With members states of the UAE sitting on reserves and investments worth hundreds of billions it is - to say the least- astounding that there is not enough money to pay off the contractors and creditors in one fell swoop. Do the 'authorities' think that this will increase their credibility (or do they need the money for urgent purchases of new race horses?). On a more serious note this is just another nail in the coffin of the internationalisation of bank lending. Closer to home the idea that lending to governments - at home or abroad - is a safe bet is being tested to the limit. It may well be a good idea to leave lending to governments to private and institutional investors. Why should it require the insertion of a bank balance sheet to fund government spending? This just increases balance sheet risk rather than remove it from the banking system. If governments become bankrupt the value of the outstanding bonds will decline in value and allow an orderly resolution of the situation via a reorganisation of debt.

Banks are still allowed to play in Private Equity?

The lack of banking reform becomes evident in the fact that Goldman Sachs is still able to play the private equity game with its own money.

Abacus CDO Deal: Moral Equivalency

It is surprising how many commentators see nothing wrong with the Paulson/Goldman Sachs Abacus CDO deal. We admit to disagree. In our business that kind of behavior would mean that we try to place a candidate we know is to be dodgy or helping to sell a business that suffers from substantial deficiencies. Thanks to our loyal clients we are in the fortunate position not to be that desperate to make a buck!

Neo-Feudalism will kill London Financial Centre

News that the FSA has reputedly blocked the appointment of John Hyman by Nomura will send a chill through the UK's financial centre. As we predicted a short while ago, any self-respecting banking professional will think twice about moving to or staying in the City of London where he is subjected to an inquisition by faceless and unaccountable bureaucrats who in all likelihood are less qualified than the people they are supposed to vet. Box-ticking and political correctness will be at a premium and who knows - the old-boy network, titles and knowing the right people will also help applicants. The right kind of leadership is essential to the success of any organisation and this vetting system will insure that over time the quality of leadership in the City will be on a downward trajectory. Hong Kong, Singapore and New York will love this!

Financial Non-Reform in the US

Should one laugh or cry? The solons have given birth to a mouse, some will love it, but who will have the last laugh?

SEC: non-report on 1000 point drop in Dow Jones

After a weekend of heavy-duty gardening your correspondent is back to the real world. This comment on the SEC's effort to bring light into the precipitous 1000 Dow point decline on May 6 caught our eye: "If the SEC were charged with writing a report on the causes of the New Orleans flood, it would provide a hundred pages telling us how many cubic meters of water there were, how many molecules of oxygen and hydrogen the water contained, and plenty of assurances that water is usually good for the health, but it would forget to mention hurricane Katrina and the broken levy." (Mark Mitchell on www.deepcapture.com). We could not have described the lame response of the 'regulators' much more accurately. Thank God the 'accident' happened in the USA as a similar incident in London would have led to the creation of a 'Royal Commission of Inquiry' at the cost of millions of pounds in lawyer's fees.

Client or Counterparty?

The controversy about Goldman Sachs' sale of the Abacus CDO raises an interesting question: are counterparties of securities firms entitled to be protected beyond the requirements of the securities laws? In our opinion, the relationship between a trader (or any business) and a customer is by nature antagonistic: one wants the highest possible price while the other wants the lowest possible one. As noted by Adam Smith, the best safeguard is an open and competitive market. This allows the 'invisible hand' to produce an outcome where both parties to the contract pursue their own (egoistic) interests and the best outcome for both of them (and society) is produced at the same time.Unfortunately, too many customers of securities firms are lulled into complacency by PR, fancy 'research', 'seminars' and other freebies and forget to do their own homework. This applies not only to retail investors but paradoxically also to 'sophisticated' investors. Already the term 'client' is designed to make the customer's eyes glaze over and induce them to think that a friendly uncle is going to sell them the latest inventions of the quant wizards on the derivative desk. But the dictionary tells us that a client is 'One that depends on the protection of another'. In reality the term should really only be applied to clients of doctors or lawyers. Fee-based financial advisors in private banks and traditional money management firms can also claim to be on the investor's side.
To ask for full disclosure from a securities dealer would be like asking a Bond Street jeweler to disclose the production cost of the latest Rolex watch and 'advise' the customer on the merits of the purchase.

Goldman PR counterattack: Risking Overkill?

Goldman Sachs' PR machine is rolling and every television and radio station is running interviews with chief executive Lloyd Blankfein. It is OK to try to bring one's message to the public but when media appearances are so well orchestrated you risk overkill and create even more suspicions about the veracity of the message you try to convey.

Derivative Clearinghouse no magic Bullet?

Harvard's Mark Roe makes a valid point when he doubts the benefits of relying on central clearing as a tool for the reduction in counter party and systemic risk in the financial markets. We argue that stress tests have to be designed so that even dramatic price changes like those experienced in the 1987 stock market crash of in the recent credit crunch pose no risk to the system. This may well mean that paltry levels of margin are on the way out. 20 percent and more may become the 'new normal'

Hedge Fund Wolves destroyed Bear Stearns?

The controversy about the role hedge funds have played - and may continue to play - in the credit and economic crisis that has erupted in 2007 can only be settled by an open and forensic analysis of all transactions entered by hedge funds during the period. All other discussions are based on guesswork, innuendo or comments from enemies or supporters of the industry with an axe to grind.

Private Equity Investment in Banks poses Risk

The wisdom of allowing 'Private' Equity firms to invest in the regulated and highly sensitive banking sector has to be questioned. Basically these firms - which are anything but private as most of their money comes from Joe Public - are leveraged players that look for the 'exit' the moment they invest in a business. As a consequence they cannot claim to be considered serious long-term investors. In addition, the 'fund' structure allows them to escape from the restraints faced by real business companies, it gives them the opportunity to drop any of their investment companies like a hot potato if things do not work out.

Credit Derivatives: Ban speculative Buyers of 'Protection'

News that speculators are betting that municipalities and federal states in the USA may default highlights the urgent need for reform of the credit derivatives market. Not only does the ballooning of outstanding trades create a substantial risk of default by one of the participants in the market it also creates problems in the wider economy by accelerating and exaggerating real or perceived weakness in the credit ratings of various issuers. There is no reason why those without an insurable asset should be allowed to buy 'credit protection' - nothing is 'protected' and it is but a speculation on default. The argument that you need speculators to facilitate a liquid market so that  investors (banks, bond investors) with genuine reasons can protect themselves,  does not hold as you really need only SELLERS of credit protection to satisfy this requirement. So speculators are more than welcome to provide liquidity as sellers of credit protection. Adjusting legislation would mean that derivatives traded outside recognised exchanges would again be unenforceable if they are not hedging against a pre-existing risk.

Goldman most powerful Bank?

Hubris comes before the fall. The headline above illustrates the danger that companies and their managements start to believe what they read in misguided press comments. Already many years ago while we were both working there a colleague of mine said that if Goldman Sachs - or any other bank - would disappear no one would notice any difference after a few days . Markets would carry on as before and would be as serene as the sea after it has swallowed a mighty ship. A single company certainly should not be able to influence the markets - that danger should be addressed by vigilant competition authorities. Unfortunately, these bureaucrats usually at best play catch-up with developments in the markets (otherwise companies like Sky UK, Microsoft, Google and Apple would already have had their wings clipped). A more sinister danger would be if companies can exert power in the political sphere. Here the multitude of links that Goldman Sachs staffers past and present have with the US Government certainly is cause for concern. But this is just another symptom of a defect of the political system in most countries where lobbies, parties or - even worse - unelected authorities (China!) make a mockery of democracy.

Lacking CDO Disclosure: Who is to blame?

It takes two to tango. The present discussion about the alleged lack of disclosure in CDO transactions directs most of the criticism towards the structuring and originating parties in the large investment banks (and their cooperators in hedge funds). While this criticism may well be valid in some - or the majority of the cases - one should not forget that no-one was forced to buy these structured products. Any attempt at regulatory reform would be simplified if the effort would primarily be directed at the buy-side. If the list of permitted transactions would be updated so that structured products are strictly controlled the supply would quickly adjust itself - both in terms of quantity and - even more importantly - in terms of quality of disclosure.

Bank Reform: Ban on non-bank business

A dispute between the City of Berlin and Goldman Sachs raises the question of the investment by banks in non-bank businesses. More than one year after the climax of the Credit Crunch that nearly brought the World's banking system to its knees it seems that little has changed. Banks still are allowed to invest in a range of unrelated businesses - whether directly or via investment funds that they control. The slowness of the regulatory process gives little hope that a similar crisis can be prevented to occur in the future.

Financial Reform: rejoinder to Ferguson and Forstmann

We are honored by the fact that the Wall Street Journal refuses to post this comment on today's article by the ubiquitous Niall Ferguson and Ted Forstmann in which they argue that efficient capital markets, no bail-out of the banking system and the avoidance of a depression are incompatible goals. This is what we had to say to this:

"Wrong, Wrong, Wrong! The three goals CAN be addressed at the same time, it just depends on how you define the words depression economy, bail out and efficient capital markets. All these terms leave plenty of room for discussion (and disagreement). Bail-outs can be done in a phased way for example, first wipe out the shareholders (and management options and restricted stock), then impose haircuts on bondholders and large depositors. Assuming that banks in the future will face tighter regulation (limits on maturity mismatch, higher capital ratios, limits on risks by industry, geography, limits on prop trading, no non-bank investments such as hedge funds or private equity) bail-out costs will be more calculable. With respect to 'efficient' capital markets we give just one aspect where there may be disagreement with respect to an appropriate definition -does an efficient capital market have to include the ability to trade share in nano seconds at the expense of the broader investing public? Reforms are possible that leave us with capital markets that are sufficiently 'efficient' to finance business and industry."

Financial Reform Bills - the case for democratic reform

When financial reform bills are 1273 and 1336 pages long as in the case of bills that have been passed or debated by the US Congress one can only say that this is legislation run amok. I would not expect a single member of congress to pass a simple multiple choice exam about the content of these bills and as a consequence one has to assume that a lot of nonsense is being passed that will hardly improve the situation for investors or taxpayers in the country. What is demonstrated by this perverted legislative process is the need to reign in overbearing and/or incompetent governments and parliamentarians. Anyone interested in how to bring this change should visit www.dirdem.org

Fabrice Tourre: Goldman's sacrificial lamb?

News that Goldman Sachs has withdrawn Fabrice Tourre's registration with the FSA here in London leaves a somewhat sour taste. All too often employees accused of wrong-doing are immediately put on leave as soon as the allegations by this or that regulatory body comes to light. This basically is an at least partial admission of guilt against which the individual has very little redress. It is a truly Kafkaesque situation were large organizations threaten the single person who of course is in a much weaker position than the people behind the bureaucracy. The irony is, that Goldman Sachs prides itself time and again for having a team approach in all it does - so it would be particularly strange that suddenly one single individual can be the only responsible party in such a substantial transaction involving prestigious 'clients'. In Tourre's case, for example, the FSA has no prima facie evidence itself, it just is hanging on the coattails of the SEC. If Goldman Sachs has any reason to suspend Touree is would beggar belief that no one else in the whole food-chain - possibly up to CEO Lloyd Blankfein - has been involved in the transaction(s) that are the subject of the SEC's case against Goldman Sachs (which incidentally is not a case just against Fabrice Tourre).

IMF - full of bureaucrats and tax dodgers

When the IMF bureaucrats call for more taxes on the banking system one can only feel a sense of revulsion. Not enough that politicians think they have to justify their existence by dreaming up a never-ending flood of regulations and spending plans, - but with them we at least have the consolation that they are subject to elections (far too irregularly though). The bureaucrats in the IMF (and similar international organisations, including the EU) face no such threat. They have secure tenure gilded by tax-free salaries. Naturally their instinct is to tax and spend other people's money, the socialist creed that keeps them in their jobs in the first place.

Disclosure no safeguard against deception

The more complicated the securities and investment businesses become, the longer are the legal disclaimers that pepper the front and back of related documents become. No wonder the 'leading' law firms now are located in what only can be described as palatial surroundings. The (mostly) impenetrable legalese is the equivalent of a mugger telling the victim to sign a document that absolves him from risk of persecution. In a sane business environment the law should be simple and not just a starting point for lawyers on their search for loopholes. Regulations should not leave any backdoor and the laws should be included in any transaction by implication. If, for example, a conflict exists between the recommendation to buy a security and the trading position of a broker-dealer it should either be (1) irrelevant or (2) prohibited. So to 'disclose' the conflict is either unnecessary in the first case or should not be an effective way out in case of claims for compensation in the latter case.

What is socially useful work?

Topical opportunity for Adair Turner, Chairman of the FSA here in London to clarify his exacting standards with respect to what is or is not 'socially useful work': is sitting on a sofa and 'reading' the breakfast news socially useful work? This is the question we ask ourselves as the BBC's Adrian Chiles is signed by ITV for a reported £6million.

Glass Steagall is good for you!

We continue to be amazed by the hysteric reaction of bankers to the possible introduction of a separation of business lines along the regulations imposed by the defunct Glass-Steagall Act of 1932 that separated commercial and investment banking for more than sixty years in the USA. Looking at it from another perspective - and not just short term/short sighted business perspectives - was the global success and dominance of the US investment banks not partially due to this enforced separation? Would the enterprise spirit not have been severely dented by keeping the entrepreneurial spirit constrained by the bureaucratic management structures of the commercial banks? A similar argument could be made in case of the City of London where the free-wheeling spirit of the financial community goes back over centuries and is in stark contrast to the top-down models of the continental European banking industry.

Dick Fuld's Ignorance: argument for smaller Banks

When the former CEO of Lehman Brothers argues that he had no knowledge of the bank's use of an accounting gimmick to hide its deteriorating financial situation we may well give him the benefit of the doubt in the absence of a 'smoking gun' proving the opposite. But it also demonstrates that even managing a financial firm such as Lehman Brothers was beyond the capability of one manager. Lehman did not have all the other business units that the typical 'Universal' Bank has under its wings (Credit Card, Consumer loans, Corporate Banking to name a few) and it still was possible that the man in command - and given his length of tenure he had the ability to know the shop inside out - did not get involved in substantial transactions such as the regular Repo 105 transactions which involved billions in balance sheet exposure. The argument that breaking up banks into smaller units would harm the economy holds no water. Why should lending to industry, and in particular to middle-sized and smaller businesses be harmed if a bank can no longer play in - to pick just one example - the structured retail client product market in Germany?

Goldman's CDO Investors - were they stupid?

The CDO product at the center of the SEC's case against Goldman Sachs raises the question: were the 'sophisticated' investors (including ironically the middleman Goldman Sachs) that bought into this transaction stupid or victims (or both)? Leaving the legal and factual arguments for the moment out of the discussion - what was the motivation that caused the fund managers at IKB and ABN Amro to buy securities that were one or two steps removed from any real underlying economic transaction? Speaking from experience I can see them as busy, maybe even diligent people who were working in a set of parameters that prevented them from questioning certain assumptions at the heart of the structured product business: that securitised products contain what the label promises, that companies with a certain public image behave in a way that confirms this image, that all players on the field can be trusted to pursue goals that do not harm the other participants.
Securitisation in particular is critically dependent on trust as the buyers in effect must give a certain amount of leeway to the creator of the product they are purchasing. The whole business idea underlying securitisation is the fact that the buyer does not want to - or is not able to - to buy the underlying assets himself. In effect, he buys a packaged product and can never expect to fully analyse all the assets - would he do so he could as well purchase these assets directly thus disposing of the need for securitisation.

Betting on my neighbours house?

Lynn Stout's point about Goldman Sachs' Abacus Mortgage Derivatives Deal (New York Times) illustrates the need for stricter derivatives regulation:

"...much of the blame for investors’ losses in the Abacus deal can be laid at the feet of an obscure statute passed by Congress in 2000, the “Commodities Futures Modernization Act.”
If we allow the unscrupulous to buy fire insurance on other people’s houses, the incidence of arson would rise sharply. In one dramatic move, that act eliminated a longstanding legal rule that deemed derivatives bets made outside regulated exchanges to be legally enforceable only if one of the parties to the bet was hedging against a pre-existing risk."

Derivative Trading can be moved to Exchanges

While it has to be accepted that not all derivatives can be traded as standardised products the overwhelming majority could be accommodated on exchanges if a few simple modifications were made: in particular, the available expiration dates have to be frequent enough (monthly series) so that most requirements can be handled. Does a corporation really need to hedge interest rate risk to a date outside the available expiration cycles? We do not think that is necessary in the majority of cases. With sufficient incentive (different capital and accounting treatment in favor of listed derivatives) most companies would choose standard contracts. Concentration of activity in listed exchanges would create a tremendous increase in liquidity and this - in addition to much higher transparency in pricing - would lead to a snowball effect in favor of listed products. Would clearing houses be able to accommodate the rise in volume and consequent rise in risk in case one party should fail? This certainly could be a problem but at least the problem would be out in the open and not hidden in the (off)balance sheets of banks (usually in the footnotes). There they are posing the same level of risk but it is clear that the only guarantee in case of a failure of a counter party is the (implicit) guarantee by the taxpayer. A clearing system has to be designed to be robust enough to withstand any conceivable failure. This means sufficient margin collateral. Stress tests have to be designed so that even dramatic price changes like those experienced in the 1987 stock market crash of in the recent credit crunch pose no risk to the system.

P.S.: Today's article in The Times about disputed valuations concerning the sale of Lehman-related derivatives during a margin call illustrates that trading of derivatives on exchanges would create a more transparent pricing system.

Bruce Wasserstein: danger of star culture

Vanity Fair's portrait of Bruce Wasserstein confirms our long-standing suspicion that he was a brilliant deal maker - for himself. The 'bid them up' method of merger 'advice', the sale of his firm to a naive Dresdner Bank and his rapid departure afterwards should be a warning for any firm that tries to build its business on the shoulders of 'stars'.  It also illustrates the Peter Principle as most organisations have their share of senior managers who have outlived their usefulness.  In this respect it is curious that a large new office is constructed for Felix Rohatyn who is about to return to Lazard as a senior advisor. This brings back memories of another new office for a senior official in the dying days of the old Merrill Lynch. Could one say there is a 'New Office Syndrome' where a big ego needs a big office to feel safe and secure in its position?

Private Equity burns its fingers with BAWAG-PSK

News that the value of the stake in Austria's BAWAG-PSK bank that the private equity fund Cerberus bought in conjunction with an investor group may only be worth a quarter of the purchase price makes sobering reading. It demonstrates that overpriced acquisitions are not only the consequence of muddled thinking by the managements of established banks but can also lead the hard-nosed managers of private equity funds astray. While traditional managers are often seduced by the excitement of the hunt the fund managers may be pressurised by the need to put to work the money they have collected in the fund.   

How to control Commercial Property Lending

A report by the US Congressional Oversight Panel states that more than half of all outstanding commercial property loans are larger than the value of the underlying property highlight the need to reign in the banking system's freedom with respect to lending to commercial property. The report prompted us to submit the following comment to the Committee:

One often has to wonder how individual 'developers' can amass huge fortunes when most of them never had a shovel in their hand. A quick glance at the list of Billionaires in the Forbes list confirms that property development (and speculation) is an extremely profitable business for the few. A lot of this apparent success is due to the endless inflationary spiral during the post-war years, some is due to entrepreneurial spirit - but a lot is also due to lax lending practices (sometimes aided by dubious practices, the least pernicious being free tickets to sports events and meals in lavish restaurants provided to loan officers).
Reform should put strict limits on the loan value of any commercial property. At the same time 'interest only' loans should also be put under the spotlight. If they are deemed to be too risky for private homeowners they are even more risky in the hands of professional speculators and cannot be allowed to put the banking system under undue risk.

Risks - Higher rates and Creditor strike

All the financial and economic geniuses teaching Finance have forgotten that credit depends to a large extent on trust (lat. credere, to believe, trust in). Banks relying on buying in deposits, companies rolling over their commercial paper on a daily basis, countries buying off their voters with ever-increasing levels of borrowing all have to face the fact that when the music stops there might not be a chair left for them in the frantic scramble to replace maturing funds.
It is even more laughable to hear that Greece  claims (supported by many 'experts') that it cannot afford to pay interest rates of 6.5 or 7 per cent. I only can say, get real guys! Rates have been in double digits in the past few decades, and anyone thinking that this cannot happen again better wake up before it is too late. Interest rates do not have to reach extreme levels, but anything in the 5-7 per cent range, with a possible overshoot towards 8 or 9 per cent is in the realm of the possible. I used to say (well before the credit crunch!) that hardly anyone was prepared for a sudden shift in asset prices by 20 per cent. Little did I know that that was a conservative estimate in view what happened during 2007/09. Now I would warn all debtors to plan for higher rates.

Deutsche Bank puts $500 million into new Hedge Fund

It would be interesting to know if Deutsche Bank invests for its own account or its clients. If the former one wonders how that fits in with designs to de-risk the banking system and limit proprietary activities?

Can trust in Securitizations be revived?

The discussion about the feasibility of reviving the securitization business revolves to a large extent about how to ensure that investors can trust the integrity of the packaging process that is behind the creation of the securities backed by the underlying loans and mortgages. The concept of securitization from the buyer's perspective means that as an investor he gets access to a multitude of loans that are individually too small to be of interest (in the case of the institutional buyer) or too large (for a small retail investor). Both are unwilling or unable to conduct individual due diligence on every single underlying loan and in effect have contracted out the credit research to the institution that creates the loan bundle they are acquiring. 
While in an ideal world the 'free market' would take care of the problem of moral hazard and ensure that no loans of questionable value are sold or purchased we do agree that the requirement for packagers to retain a substantial stake in the securitized product is a sensible suggestion. While this may well raise to cost of the securitized package we think this is a price worth paying given the abuses that helped create the credit crunch of 2007-09.

Compensation vital cost factor

Over the years we have observed the rise and (more frequently) decline of many investment banks. As compensation is the key cost factor in the industry a sensible compensation structure is essential to achieving long-term success in the business. So when we read that the centuries-old private bank of Sal. Oppenheim had agreed to pay a former chief executive of Arcandor the princely sum of 4 million Euro a year for being an advisor (and on top of it give him a three-year contract) we were not surprised that the company had to be sold to Deutsche Bank. To throw around money like a drunken sailor can only end up with the business withering away due to lack of profitability. The situation at Lehman Brothers (and the old UBS before it was swallowed by Swiss Bank Corporation) was not dissimilar. The level of compensation was completely out of whack and while it may not have been the deciding factor in the demise of these enterprises it certainly was symptomatic for a general lack of good management and governance. Sensible recruiting is one - if not the - key factor in the success of a people business like investment banking - as well as in banking, securities brokerage and investment management. 

Global Banks need Global Regulation

The collapse of Lehman Brothers which had nearly 900 subsidiaries in around 20 jurisdictions demonstrates that financial institutions that want to be active on a global basis also need to be regulated on a global basis. The alternative has to be that each subsidiary is regulated on a watertight national basis (with its own capital requirements). Politicians and Regulators have to give a clear-cut response to the question what would happen if a globally-active bank with large operations in several countries gets into serious difficulties. As banks spread their wings wider and wider - see Banco Santander and Unicredit for example - an answer to this question becomes more and more urgent. Can their clients rely on the backing of their home country or is the government of the host country expected to write a blank cheque if the worst should happen? The case of the Icelandic banks should have been a wake-up call.

Reshaping US Mortgage Market

It beggars belief that a country that prides itself of its superior financial markets is not able to provide mortgages on a private basis. Apart from the fact that state-subsidised institutions may have distorted markets and driven out private-sector institutions it is amazing that a chastised banking industry prefers to pursue profits in more exotic segments of the financial markets rather than catering to the real needs of ordinary people.

Financial Reform (No) Progress Report

Politicians, regulators and industry representatives so far do not disappoint our (low) expectations. The main idea that seems to be gathering support is (surprise, surprise!) the introduction of more taxes. As usual the proceeds of the muted taxes are not going to be earmarked and will in due course be diverted to 'socially' worthy causes. 

One regulator behind each banker!

That is the ultimate destination of the effort to create regulation for a stable banking and financial system. It is the logic of central planning (and regulation is nothing else) that the rulebooks have to be more and more detailed to cover every eventuality. In order to be effective more and more decisions will have to be supervised in minute detail by an ever-rising army of regulators. Banking professionals may love this as the bureaucrat/regulator takes all responsibility for decisions from their shoulders as each and every decision would have to be approved. A useful side-effect may be the contribution this would make to the growning lack of employment opportunities in many Western countries as it would entail a doubling of employment in the financial service sector.

USA: desperate search to increase tax revenue

It is ironic that in a week when the helpless US Treasury Secretary Tim Geithner pens a letter complaining about presumed unfair treatment of US alternative investment funds in the EU the US passes a law ('Foreign Tax Compliance Act') that forces all non-US financial institutions to report their dealings with US citizens. Against the background of a dysfunctional Congress and an administration that is spending money like a drunken sailor this desperate measure should not come as a surprise. The underlying philosophy is that a citizens' money really belongs to the state and it is up to the politicians to spend it. We do not expect the authorities to give a clear 'Njet' to this effort to extend the reach of US legislation one step further into other sovereign countries but it will do nothing to make it any easier for the US to fund its deficit in the future. Already some institutions have decided not to have any financial dealings in or with the US and as the next step may well be that the USA tries to help themselves to the wealth of non-US citizens we would advise investors to sponsor fund managers that take precautions for that eventuality.

FSA hellbent on destroying London as a financial centre

The FSA - which operates as a Quango with only the slightest amount of democratic oversight and legitimacy - intends to bring the number of paper-pushers to the incredible total of 3700 by the end of 2010. If one remembers that the City of London worked perfectly smoothly for centuries and well into the 1980s without any monstrous 'oversight' by bureaucrats the scale of this misdirection of taxpayer resources becomes more evident. When Lord 'Alliswell' clarifies that he considers much of financial market activity as 'economically' not useful he indirectly admits the intellectual bankruptcy of his thinking. To enter the debate about what is or is not 'economically useful' is a debate which only leads to the quicksands of moral do-goodism where some (usually self-appointed) authority tells other people what is good for them. The good Lord owes much of his status (and income!) to his being in favour with those in power and very little to him supplying 'valuable economic services' to the citizens. The savers in this country are those that really pay for the empire building activities of those behind the ever-expanding army of bureaucrats in the FSA. That all this spending will lead to the inevitable decline of the City of London as a financial centre is probably of no concern the the authorities. They may well talk the talk in favour of the City but one should watch what they are doing!