Overpaying for Acquisitions

We were quite staggered by the prices some Western Banks paid when they acquired banks in 'high growth potential markets' in Eastern Europe or other Emerging Markets. Case in point is Austria's Raiffeisen that supposedly paid nearly Euro 1 billion for Ukraine's Bank Aval in 2005. This represented nearly two thirds of Aval's balance sheet. Similarly high multiples were shelled out by other banks while we continuously advised that it would make more sense to plough the money into organic expansion. After all, the banks that were acquired were themselves only built up over a short time-span nor had they proven themselves through the business cycle.

How to regulate Derivatives

Warren Buffett famously described Derivatives as Weapons of 'Financial mass destruction' (2002 Letter to Shareholders of Berkshire Hathaway). While we think that this catchy phrase exaggerates the dangers of derivatives it has to be accepted that these contracts are essentially bets similar to futures contracts. As they are highly leveraged - in contrast to futures contracts there often is no margin at all - and no money may change hands when the initial contract is signed they are susceptible to outright fraud or abuse by overambitious traders and financiers. We would like to add to the debate by suggesting that all forms of derivatives are subject to meaningful margin requirements (including capital requirements in balance sheets of banks, insurance companies, corporations and public entities).

Goldman and Greece: Barron's pullls no punches

Barron's Magazine is traditionally a magazine that defends free markets and capitalism. So it comes as a surprise when the Editorial Comment has a go at Goldman Sachs and Wall Street firms in general. When a stalwart of the business community like Barron's and not some leftist publication starts to call them 'Wall Street casino sharks' (sic) is it not time that these firms start to listen and change their business models?

Poor Defense of Speculation

Darrell Duffie tries to revive well-worn arguments (Wall Street Journal, 24 Feb 2010) in defense of unrestrained speculation and does a disservice to free markets by leaving the door open for anti-market regulators. As a Stanford University professor one would expect him to show more awareness that certain speculative activities may well require more regulation in order to allow the rest of the financial markets to function without attracting counterproductive over regulation. Speculation may well serve a useful purpose - some times, maybe most times, but not always. For example, if speculators are allowed to buy insurance on my house (and even hire someone to burn it down in order to cash in on the insurance) then things have gone too far. But that threat exists when there is unrestricted speculation in short selling of shares, CDS contracts and distressed debt.

The Donkey and BNP Paribas

Watching CNBC I could hardly believe my eyes when I spotted a middle-aged French lady rattling on about her life, that she dreamed of being rich when she was young. This was quickly followed by a rustic-looking chap from the West Bank who told us how happy he was to feed his donkey. The suspense built and I thirsted for the commercial break on CNBC to end so that I could find out which company was willing to shell out money for such incoherent testimonials. I expected it to be some charity, maybe linked to the United Nations. But the surprise winner was -- BNP Paribas! Having just closed today's Financial Times where a back page was adorned by the picture of Roger Federer it made it all-too-obvious that advertising has taken on a life of its own in the banking industry. Is it really all about image? Is it impossible to differentiate yourself by promoting a better product and outline the benefits it may bring to the customer? Does it really matter to a customer of Credit Suisse how many matches Roger Federer may have won? (650 in case you wonder). At a time when banking worldwide is an industry under siege - and we may not yet have seen the worst of the political onslaught - one would hope that managements put their advertising departments on a tighter leash.

Fraud Prevention - Banks walk on thin Ice

News that a subsidiary of Nord LB (Norddeutsche Landesbank) in Switzerland may have fallen victim to a fraud in its trade finance activities that may cost it up to Euro 130 million is a timely reminder that banking is a hazardous business where a premium should be put on credit and operational supervision and due diligence. All-too-often senior management is preoccupied with 'strategy' or political infighting and pays little or no attention to what is going on further down in the organisation or in outposts of a far-flung (overextended?) empire.

BNP Paribas Compensation: A Model to follow?

BNP states that is will reduce its compensation-to-income ratio to 27 per cent for FY 2009. In doing so management claims to address public (political) concerns over excessive pay. BNP certainly seems to navigate successfully through the twin challenges of keeping regulators sweet and running the business smoothly while competitors stumble over PR gaffes or management mistakes. However, we do have a sneaking suspicion that pressure on compensation levels in the large investment banks will contribute to a revival of smaller competitors that are not in the limelight and are less subject to regulatory fervor.

Goldman Sachs Business Principles

We still have the last edition of Goldman's phone directory that we received before moving on.

Point 1 states: Out clients' interests always come first. Our experience shows that if we serve our clients well, our own success will follow.

Point 2: Our assets are people, capital and reputation. If any of these are ever lost, the last is the most difficult to regain.

We hope that these points still feature prominently in the phone directory (which by now will probably be in electronic form only).

Greece: Why not declaring bankruptcy?

Martin Feldstein's piece in yesterday's Financial Times (Let Greece take a holiday from the Eurozone) caused us to send him a brief note and we will watch the reply of the sage with interest:

Dear Mr. Feldstein!

Your article - like most other articles concerning the Greek Debt Saga - tacitly assumes that one simple way to solve the problem is not feasible: a declaration of bancruptcy and subsequent resolution comparable to Chapter XI in the USA.

At present, the only two options that are being discussed are (1) a bailout by EU member states or (2) Greece leaving the Eurozone. Eliminating the option of bancruptcy from consideration creates an unproductive stalemate between two diametrically opposed viewpoints (aften aggravated by different ideologies regarding the philosophy behind the creation of the Euro).

Harmonised Stress Tests - Good in Theory

CEIOPS plans to introduce a harmonised stress test for Insurance companies in Europe. While this is a worthwhile project it will create one practical problem: what amount of stress will be applied to the balance sheets of the insurers? Well before the Credit Crunch started in the middle of 2007 we often asked the question: What would happen in the hypothetical case that all asset prices drop 20 per cent? would the banking and financial system in general be able to withstand such a shock - given that the margin of safety on a lot of lending was much less than that! We all know the answer to that question and I think that lessons still have not been learned. The problem is, that only by relying less on debt and debt instruments (in any form) and more on equity will the risk of a financial meltdown be successfully contained. Regulators will be hard-pressed to set the appropriate level of 'stress' in any test - too much and they regulate the insurance industry out of business, too little and the test becomes meaningless.