FSA wants tougher stress tests

As the FSA here in Britain announces new - tougher - stress markers for UK banks we can only hope that the underlying economic model holds up in case another economic crisis hits the banking system. We all know what happened to the Value-at-Risk Model - it was less than useful when it was needed most. The problem with stress-tests in banking is that it is impossible for the banking system as it is at present to provide for every conceivable disaster scenario as that would mean that ultimately the banks would have to hold all deposits 100 per cent in cash.

Lower Leverage-ratio under fire

The Federation of German banks has commissioned a study of the impact of stricter leverage ratios. Not surprisingly, the authors (Markus Rudolf and Michael Frenkel from WHU Otto Beisheim School of Management) come to the conclusion that the introduction of lower ratios would have to be handled very carefully - and may not even be desirable. To the contrary, we think that the suggested ratio of 20-25 times equity capital as a maximum range of leverage (as suggested in a consultation document presented by the Bale Committee last December) leaves the banking system still dangerously overextended.

Who needs rating agencies?

Warren Buffet certainly does not need them as he prefers to do his own analysis. We also suggest that investors do their own cooking. The only instances that makes ratings useful for investment decisions happen to be the situations where the consensus and/or ratings appear to cause a mispricing in the underlying security that allows a canny investor to benefit by taking the opposite side of the trade. As long as ratings are based on hard facts, usually numbers found in company accounts or data in national statistics, it is a simple matter of arithmetic to deduce the risk associated with a particular issuer. Where ratings rely on judgement calls they become highly subjective and should not be worth more than any other market opinion. Conflicts of interest exist when ratings agencies are given access to non-public information. As it is not possible for other investors to verify the information themselves, some lazy or naive investors get seduced to put excessive reliance on ratings decisions. This risk is exacerbated when laws or customs give ratings an official blessing - for example by requiring collateral posted with the European Central Bank to be of a certain credit quality testified by a rating.

Jon Corzine defending Goldman Sachs

One has to wonder what moral authority Corzine has to defend his former employer from what he calls 'envy'. A man who so blatantly makes a mockery of democracy by spending his vast wealth in securing himself public office should keep a low profile. Support of that kind is the last thing that Goldman needs given its image problems.

Warren Buffett on foolish acquisitions

In his 2009 Letter to Shareholders the sage from Omaha says it better than we ever could: many acquisitions are value-destroying.

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.