30 Apr 2010

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.

27 Apr 2010

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.

23 Apr 2010

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."

22 Apr 2010

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).

21 Apr 2010

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.

20 Apr 2010

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.

18 Apr 2010

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."

14 Apr 2010

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.

13 Apr 2010

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?

11 Apr 2010

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.   

9 Apr 2010

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.

8 Apr 2010

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.

3 Apr 2010

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?