Derivatives: Instruments of Mass Destruction?

Another day, another disclosure of a massive derivative loss. Given the astronomical amount of outstanding (OTC) derivative contracts (and even astronomers that are used to think in big numbers might have trouble relating to the relevant numbers) it is no wonder that these 'accidents' pop up on a regular basis. Low or non-existent capital requirements make these off-balance sheet exposures attractive for treasurers and CFO's. They require little or no cash up-front so give the somewhat false impression that entry to the great casino is free and profits will flow like manna from heaven. Sometimes they are sold as hedging instruments - and they might well be fit for the purpose but the iron discipline needed to stick to that narrow use is not given to all market participants. And many users are easy prey to the salespeople that are highly incentivised to peddle ever-more exotic schemes that resemble a 'heads I win, tails you lose' game. And given the fact that derivatives are ultimately a zero-sum game it is only natural that those offering these products are above all interested in making sure that they are not on the losing side of any derivative deal. Derivatives may well have a place in the arsenal of any financial market participant - but have to be supervised by experienced experts who can give an objective assessment of the risks and rewards involved.

Goldman: plays a simple game better than most

Quarterly figures just released by Goldman Sachs this morning demonstrate (again) that the firm plays - what should be a simple game - better than most competitors. No need for expensive consultants to figure that out, just common sense and experience.

JP Morgan: Review of the 'Whale' Trades

Nothing but a very thorough review of the losses made by the 'Whale' was to be expected but one still has to wonder how much good this report will do. Its recommendations certainly will keep a lot of regulators and JP Morgan staffers very busy in the future. But looking at the quite unstructured text in the 18 pages it contains hints at the main problem any financial institution faces: complexity and human frailty combined with a good mix of fear, risk and greed. Setting up ever more complex procedures and review bodies will only go so far and never be a perfect substitute for common sense and competent, honest and modest people.

UK: Hellbent on destroying its banks?

Readers know my scepticism with respect to the LIBOR witch hunt (and the PPI/payment protection insurance brouhaha that is completely blown out of proportion and turns all notions of individual responsibility on its head). But if there is any truth to it that the regulatory jobsworths (and their political puppetmasters) put pressure on Royal Bank of Scotland to get rid of two senior executives than one really has to say that the 'Coalition' here in the UK is hellbent on destroying what is left of indigenous UK banking institutions. Cameron and Osborne (and with a little bit of luck Nick Clegg as well) will find themselves cushy jobs with their Etonian or City friends and hangers-on after (as I would expect) they lose the next election. But the taxpayer and citizens of the country would have seen their (involuntary) investment in RBS go down the tubes.

Libor Trades - Simplistic Calculations

Reports about the profits that Deutsche Bank is supposed to have made (where can we finally expect to see a hard copy of dollars and cents?) are simplistic to say the least. Of course, ALL trading houses will (hopefully) have made money from 'Libor trades'. The alternative would have been to have lost money in these trades. But as even any intern serving in an investment firm knows, that does not mean that any profit has been made in an improper fashion. Have any of the critics in the media, politics and regulators even had a good look at the acres of office space trading desks occupy? do they know how many different desks and investments are linked to Libor? Then they would understand that even the efforts of a group as large as the (supposed) group of UBS staffers can hardly have shifted the actual Libor rates produced collectively by ALL the contributing banks by more than a tiny amount. And even within UBS, for example, there would have been winners and losers on any given day, just that the people responsible for Libor quotes may have gained a small advantage at their expense. But for that I still would like to see actual proof and not general displays of shock, horror etc

Banks: Time to get out of Europe!

Recently 500 (in words: five hundred!!) policemen were delegated to conduct a search at Deutsche Bank's headquarters. Anyone with half a brain will realise that to set loose such a large group to do a job for which they are less than qualified can only be motivated by political reasons. So it would be only natural that the Co-CEO of the business - which is after all a significant employer and taxpayer - would be in his rights to lodge a complaint with the political overseers of the judiciary and police. After all, the temporary 'constitution' of Germany is less than punctilious about a proper separation of the powers of government. But when this simple complaint causes a hysteric reaction among the ruling political establishment - fanned by a media that sings to the same collectivist hymn sheet - then it would be time for any self-respecting institution to ask itself if it is worthwhile to stay domiciled in the country or debark to friendlier shores. The same question should be asked by HSBC, Standard Chartered and any bank that does not simply want to become a 'utility' (ab)used to finance spendthrift states.

Merger Blues: Another day, another Write-off

Now it is Legg Mason's turn to eat humble pie and write off a major junk of its investment in Permal, the hedge fund group. No blame sticks to Permal though as no one (except maybe some advisers too keen on their fees?) held a gun to Legg Mason's head and forced them to pay over the odds. It remains to be seen if adding some heft to Permal's assets via the acquisition of Fauchier will help to right the ship. Fund of Hedge Funds are relatively new businesses, often built by one or a handful of entrepreneurs and the task of creating a lasting enterprise culture is a daunting one. The purchase is the easy thing!
Permal to acquire Fauchier Partners (Financial Times)

Man Group faces huge write-off on Acquisition

It was clear to me from the outset that the decision by Man Group to acquire the hedge fund GLG was more out of desperation (to diversity, or as Warren Buffett would say 'diworsify') than rational calculation. While the hedge fund business has been - and will remain - a good business to be in it requires more than any other business a fine judgement of people, enterprise cultures and business trends. Needless to say, the 'advisers' on both side of the deal above all will be interested to bank their not inconsiderable fees while wash their hands of any subsequent problems that may emerge post-deal.
Man Group faces heavy GLG write-off (Financial Times)

Libor: The Shakedown gathers steam

When I originally commented on the Libor 'Scandal' I got a surprisingly strong reaction from readers - even those that normally are quite critical of  'Ueber-Regulation' disagreed with me. But it is still less than clear who has really lost money due to the supposed manipulation - and if so, how much was lost (Dollars and Cents please you righteous citizens!). An article in the Daily Telegraph points out that from a legal point of view a successful prosecution is less than certain. So today's announcement that UBS alone might face penalties of close to $ 1 billion can only be understood in a climate of witch hunt mixed with a supine and spineless management culture in the banks concerned. After all, senior management wants to sleep quietly and does not give a damn about the shareholder's money. Similar abuse is rife in the so-called mis-selling 'scandals' related to payment protection insurance or sales of derivatives. Reader replies such as this one are not very illuminating (except about the public's attitude towards the banks) as they are unable to shed more light on the crucial question of who has lost (or maybe gained) how much from any Libor fixing.

An interesting discussion may be seen on this thread (Financial Services Regulation, Linkedin)

Distastrous Acquisitions

Rumors have it that Bank Austria may lose nearly 80 pct of the more than $US 2.2 billion that it paid for Kazakhstan's ATF bank in 2007. Together with the huge write-off that Credit Agricole recently had to make on its Greek adventure and the problems that
Man Investment has digesting its acquisitions this provides more evidence that poorly planned and/or executed acquisitions can prove to be hugely expensive.