Lehman: Masters of the Universe R.I.P.

The sense of hubris that was prevalent at Lehman Brothers before the fall is well documented in a new book The Devil’s Casino: Friendship, Betrayal and the High Stakes Games Played Inside Lehman Brothers, by Vicky Ward. It mentions that one of the top honchos in the firm, Chris Pettit, got by with a personal spending budget of $ 15 million (!!) a year. With leadership of that kind it is no surprise that the company had to hit the rocks sooner or later. The question one has to ask is what lessons - if any - has the securities industry from the credit crunch?

Repo transactions under a cloud

Reports that Lehman relied heavily on repo transactions in order to disguise problems with its balance sheet highlight the need for tighter restrictions on repo's. Like commercial paper, most repo deals are short-term in nature and therefore unsuited for the financing of longer-term assets. Funding based on repo's, commercial paper and similar instruments should be used exclusively for the financing of assets with a matching maturity profile and capital requirements should allow for a sufficient margin to provide for extreme events.

Geithner intervenes in EU hedge fund regulation

One has to wonder what Tim Geithner's priorities are at a time when the USA faces an unprecedented gap in its budget and the economy has just left the intensive-care ward. The USA puts massive restrictions on foreign fund managers that try to market their services or securities to its citizens, the boilerplate restrictions on most securities prospectuses and fund manager's brochures and websites bear witness to that. Why should the EU not have the right to protect its citizens? Any non-EU fund manager is welcome to set up a EU-compliant subsidiary and thus get access to a market of 500 million people.

Causes of the global credit crunch

It is too early to fully understand how it could happen that the World's Financial System got close to a global meltdown during the past 12 months. Some blame greedy bankers, others lay the blame squarely at the foot of the (US) consumers. Institutional Investors also appear entangled as they allowed managements too much leeway and even egged them on to pursue ever-more risky expansion plans. However, we tend to think that regulators - and their paymasters the politicians - may have to take a large part of the blame.
Unfortunately they are the party that is the least likely to bear the full cost of their mistakes. Shareholders have to suffer from dramatically shrunken share prices, scores of bankers have lost their jobs, or are about to in the near future. Bureaucrats are happily engaged in the blame game and are joined by academics and media people who often are also less than objective in their judgement.

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.