Client or Counterparty?

The controversy about Goldman Sachs' sale of the Abacus CDO raises an interesting question: are counterparties of securities firms entitled to be protected beyond the requirements of the securities laws? In our opinion, the relationship between a trader (or any business) and a customer is by nature antagonistic: one wants the highest possible price while the other wants the lowest possible one. As noted by Adam Smith, the best safeguard is an open and competitive market. This allows the 'invisible hand' to produce an outcome where both parties to the contract pursue their own (egoistic) interests and the best outcome for both of them (and society) is produced at the same time.Unfortunately, too many customers of securities firms are lulled into complacency by PR, fancy 'research', 'seminars' and other freebies and forget to do their own homework. This applies not only to retail investors but paradoxically also to 'sophisticated' investors. Already the term 'client' is designed to make the customer's eyes glaze over and induce them to think that a friendly uncle is going to sell them the latest inventions of the quant wizards on the derivative desk. But the dictionary tells us that a client is 'One that depends on the protection of another'. In reality the term should really only be applied to clients of doctors or lawyers. Fee-based financial advisors in private banks and traditional money management firms can also claim to be on the investor's side.
To ask for full disclosure from a securities dealer would be like asking a Bond Street jeweler to disclose the production cost of the latest Rolex watch and 'advise' the customer on the merits of the purchase.

Goldman PR counterattack: Risking Overkill?

Goldman Sachs' PR machine is rolling and every television and radio station is running interviews with chief executive Lloyd Blankfein. It is OK to try to bring one's message to the public but when media appearances are so well orchestrated you risk overkill and create even more suspicions about the veracity of the message you try to convey.

Derivative Clearinghouse no magic Bullet?

Harvard's Mark Roe makes a valid point when he doubts the benefits of relying on central clearing as a tool for the reduction in counter party and systemic risk in the financial markets. We argue that 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. This may well mean that paltry levels of margin are on the way out. 20 percent and more may become the 'new normal'

Hedge Fund Wolves destroyed Bear Stearns?

The controversy about the role hedge funds have played - and may continue to play - in the credit and economic crisis that has erupted in 2007 can only be settled by an open and forensic analysis of all transactions entered by hedge funds during the period. All other discussions are based on guesswork, innuendo or comments from enemies or supporters of the industry with an axe to grind.

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.

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.

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."