A Stalinist Approach to Banking

The head of Bafin, the German banking regulator, boasts that his staff will become 'permanent guests' in all major banking institutions. This confirms our long-standing theory that only ever-closer control of all aspects of banking will satisfy the politicians' urge to supervise the business and make it conform to their wishes. Every rule needs interpretation which means another rule which leads to another rule and so on. As no one wants to make a mistake each decision will have to be cleared with a supervisor. At the end there will be a stalinist system of one 'commissar' standing behind each front line banker and the banking system will be completely ossified. 

Cash bonuses reduce risk - Study

Banking regulators all over the world think that it will help to reduce the risk of the banking system if they require a larger portion of total compensation to be paid in the form of equity. A recent study refutes this notion and tries to demonstrate that cash incentives are better suited to achieve a less risky banking system.

Musings of a Hedge Fund Manager

If ever you thought that the books on management you read at University were full of obvious platitudes you have seen nothing yet. Ray Dalio, the founder of Bridgewater, may have been successful - being in the right place at the right time and starting a money management business at the bottom of the market in 1975 must have helped - but I wonder how he could have found it useful to concoct a philosophy or life and business that just is a very poor copy of what one can find in countless books about self-improvement that are so popular in America.

Bank Capital should be 13 pct - Basel Committee

The problem with defining the appropriate level of capital that banks should hold on their balance sheet is that in a general panic no amount of capital is adequate to deal with a bank run. For many decades banks could get by with wafer-thin margins of safety as generally confidence in the integrity of the banking system was high. Tinkering with capital requirements may be but one step in the right direction. Banking reform needs additional measures to be successful.

Image Campaigns - do they make sense for Banks?

Both Credit Suisse and UBS have recently launched advertising campaigns that are aimed to bolster their brand image. But does the sponsoring of Formula One really help UBS to reclaim lost ground with the high networth clientele that must surely be the main target for its marketing efforts? 
Image Campaigns may well have a role to play for banks that are active in the mass market but for banks that are mainly involved in the institutional or high networth market a more focused approach must be the preferred route. 

 
 

Who should regulators be accountable to?

The complaint by financial sector trade bodies about proposed changes to the UK's regulatory system raises the interesting question about the accountability - or lack thereof - of the financial regulators.  UK banks fear that the scrapping of the Financial Services Authority (FSA) will leave power in the hands of a small, unelected group. But can one really say that the FSA was accountable just because it was required to hold an annual public meeting and had to hold regular meetings with senior industry managers through its so-called Practioners' Panel? We wonder what the outcome of the Credit Crunch would have been if the regulators would have been subject to full democratic control during the past few years. If anything the reaction to the crisis would have been less decisive and therefore less effective. Democratic control would better be applied during the stage in the legislative process when the framework for the regulatory regime is designed and there is time for more - and more broadly based - discussion between all parties involved. That would allow the voice of taxpayers and consumers to have more weight in the ultimate outcome.

Pay rules: Bureaucratic nightmare in the making?

A report by PriceWaterhouse raises the spectre that new pay regulations could be applied to thousands of financial services firms. While the usual sham 'consultations' are conducted by the FSA we can confidently predict that by implementing new pay regulations beyond the small group of systemically important banks the dead hand of government would certainly make one mighty step towards killing the goose that lays the golden (tax) eggs in the City of London.
The average employee has zero influence on the overall risk profile and financial performance of his employer. A small circle of top managers is wholly responsible for the success of any enterprise in our system of corporate governance and any major delay in paying the much-needed pay-checks to staff further down the rung will only massively demotivate staff - and in many cases make them willing to consider a move to friendlier shores.

Verdict on Dood-Frank bank reforms

This quote (Liam Halligan, Sunday Telegraph, 25 July 2010) says it beautifully:

"Based on sound-thinking courageous judgement, the Glass-Steagall legislation was only 17 pages long. Packed with wheezes and loop-holes, Dodd-Frank runs to 2,319 pages. Enough said"

Limits to Vulture Funds?

A report about buyers of under-performing mortgages trying to strong-arm borrowers points to the problems that can be created by unfettered trading in loans. What treatment can borrowers - be they individuals, companies or countries - expect in a financial environment where every loan is for sale? Borrowers select lenders not only on price but also on reputation. They want to know who they deal with and do not expect the representative of an aggressive vulture fund to knock on their door if they struggle to meet repayment terms. 

Goldman cannot separate Derivative Profits

from its profits in cash securities. According to Bloomberg Goldman Sachs has refused to disclose how much it makes trading derivatives to the Financial Crisis Inquiry Commission. Goldman CFO David Viniar stated that the firm 'has no way of separating out its derivatives data from trading in cash securities'.
We can only assume that some information got lost on the way from the FCIC to the reporter as we can not imagine that at a time when computing power is so abundant it would not be possible to separate the profitability by product - down to the P&L of each individual transaction.

Re-Recruit your team every day

In this interview the CEO of The Limited makes the interesting point that 'her job is to re-recruit her associates every day and give them a reason to choose to work for us and for her as opposed to anybody else'. Definitely a good point, - especially in view of the fact that so many relationships between boss and employee are adversarial rather than cooperative.

Lagarde: Stress tests will show EU banks healthy

Strange that she seems to know what the tests that are currently performed will look like.

Germany: Compliance Madness

It is well-known, that thanks to Karl Marx Germany 'gifted' Communism to the World. He may not have been the sole inventor of this creed but he certainly perfected a system that brought unhappiness to millions of people in its wake. Germany may not be considered to be at the cutting edge of the development of financial markets but the unreformed bureaucracy that holds the country in its grip certainly makes a meal of it when it comes to throw an -ever-tightening net of useless and costly controls over the activity of German citizens. Officialdom still lives in Kaiser's times when a citizen could truly be called an 'Untertan'. Little does it matter that the problems of German banks are mostly due to political interference in the Landesbank system that should have been abolished decades ago. Little does it matter that managements of certain private banks were making serious mistakes (and have in some cases been rewarded with princely retirement packages). But the bureaucrat's reaction is typical in as much as statism calls for ever-tighter prescriptive controls in order to 'improve' the system. Logic dictates that the end of this process is an ossified system that will at some stage resemble Cuba, North Korea or the former Soviet Union. Every step will be controlled, have to be submitted to approval by a 'commissar'. That the 'Elites' of Europe at this moment congratulate themselves (the utterly silly finance minister of France was seen to clap her hands at the signing ceremony) to have initiated another scheme to reward to undeserving (called EU 'Safety Net') is fitting testimony to the utter contempt they hold the subjects in their member states. It is offers little consolation that the situation is hardly any better in most other countries as governements seem to be in a concerted arms race to more control rather than proper reform of their economic and political systems. Unfortunately, the dominating system of 'pseudo-democracy' will allow the creation of more and more bad legislation. Only a system of direct democracy which we advocate will allow citizens to reign in unaccountable politicians and bureaucrats.

Banking: Maturity Mismatch continues

Reports about increasing levels of stress in bank funding should surprise no one. One of the key lessons - if not THE key lesson - of the Credit Crunch should have been that the Banking System was in need of a complete overhaul of the liability structure. Financing long-term assets and loans with shorter-dated liabilities may have worked in the days of sedate financial and economic structures in the period after WWII up to the 1980s. But an existence relying on hand-to-mouth feeding of liquidity from deposits that are for periods of days, weeks or even months was - and is - a recipe for disaster. Money Market Funds feed the illusion of liquidity on the asset side and are a further contributing factor to this asset-liability mismatch as is the enormous amount of commercial paper rolled over by companies as well as financial institutions. 

FSA behaves like a traffic warden

The FSA is a enough of a burden for the ordinary saver in this country. More than 4000 bureaucrats are well paid to push around paper and a corresponding army euphemistically called 'compliance officer' has to be fed on the other side of the fence . That those prosecuted face an inquisitorial regime becomes obvious from this case: like the victim of the traffic warden who faces extortionate costs if he does not immediately pay up the FSA's victims face the insult that they have to pay for ludicrously high prosecution 'costs' when the bureaucrats in their secure job (and without any proper accountability) are already paid their safe salaries by the taxpayer/saver. As in all legal cases in this country there are no proper checks on fee gauging as in other countries where the lawyer's fees are set in strict accordance to the amount of the claim.

Bank Chief: Savers should lose in bank failure

We tend to agree with Peter Sands, chief executive of Standard Chartered, who said "that people with savings above any sum guaranteed by law — £50,000 in the UK — should be hit with other providers of capital if a bank fails" (The Times). But we think that a small - but important - group that was left out in the proposals were the senior executives of the banks. Having their money at stake did not stop senior management of Bear Stearns and Lehman to run their companies into the ground but in this post-crunch area it would certainly be a useful addition to the armoury of regulators if managements would have more at stake than just their jobs in case a bank should get into trouble. Given the vast amounts of bonuses, share options and other perks the compensation beyond a reasonable basic salary should be mandatorily vested during their employment and for a minimum period after they leave the bank.

Dubai debt settlement leaves sour taste

With members states of the UAE sitting on reserves and investments worth hundreds of billions it is - to say the least- astounding that there is not enough money to pay off the contractors and creditors in one fell swoop. Do the 'authorities' think that this will increase their credibility (or do they need the money for urgent purchases of new race horses?). On a more serious note this is just another nail in the coffin of the internationalisation of bank lending. Closer to home the idea that lending to governments - at home or abroad - is a safe bet is being tested to the limit. It may well be a good idea to leave lending to governments to private and institutional investors. Why should it require the insertion of a bank balance sheet to fund government spending? This just increases balance sheet risk rather than remove it from the banking system. If governments become bankrupt the value of the outstanding bonds will decline in value and allow an orderly resolution of the situation via a reorganisation of debt.

Banks are still allowed to play in Private Equity?

The lack of banking reform becomes evident in the fact that Goldman Sachs is still able to play the private equity game with its own money.

Abacus CDO Deal: Moral Equivalency

It is surprising how many commentators see nothing wrong with the Paulson/Goldman Sachs Abacus CDO deal. We admit to disagree. In our business that kind of behavior would mean that we try to place a candidate we know is to be dodgy or helping to sell a business that suffers from substantial deficiencies. Thanks to our loyal clients we are in the fortunate position not to be that desperate to make a buck!

Neo-Feudalism will kill London Financial Centre

News that the FSA has reputedly blocked the appointment of John Hyman by Nomura will send a chill through the UK's financial centre. As we predicted a short while ago, any self-respecting banking professional will think twice about moving to or staying in the City of London where he is subjected to an inquisition by faceless and unaccountable bureaucrats who in all likelihood are less qualified than the people they are supposed to vet. Box-ticking and political correctness will be at a premium and who knows - the old-boy network, titles and knowing the right people will also help applicants. The right kind of leadership is essential to the success of any organisation and this vetting system will insure that over time the quality of leadership in the City will be on a downward trajectory. Hong Kong, Singapore and New York will love this!

Financial Non-Reform in the US

Should one laugh or cry? The solons have given birth to a mouse, some will love it, but who will have the last laugh?

SEC: non-report on 1000 point drop in Dow Jones

After a weekend of heavy-duty gardening your correspondent is back to the real world. This comment on the SEC's effort to bring light into the precipitous 1000 Dow point decline on May 6 caught our eye: "If the SEC were charged with writing a report on the causes of the New Orleans flood, it would provide a hundred pages telling us how many cubic meters of water there were, how many molecules of oxygen and hydrogen the water contained, and plenty of assurances that water is usually good for the health, but it would forget to mention hurricane Katrina and the broken levy." (Mark Mitchell on www.deepcapture.com). We could not have described the lame response of the 'regulators' much more accurately. Thank God the 'accident' happened in the USA as a similar incident in London would have led to the creation of a 'Royal Commission of Inquiry' at the cost of millions of pounds in lawyer's fees.

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."

Financial Reform Bills - the case for democratic reform

When financial reform bills are 1273 and 1336 pages long as in the case of bills that have been passed or debated by the US Congress one can only say that this is legislation run amok. I would not expect a single member of congress to pass a simple multiple choice exam about the content of these bills and as a consequence one has to assume that a lot of nonsense is being passed that will hardly improve the situation for investors or taxpayers in the country. What is demonstrated by this perverted legislative process is the need to reign in overbearing and/or incompetent governments and parliamentarians. Anyone interested in how to bring this change should visit www.dirdem.org

Fabrice Tourre: Goldman's sacrificial lamb?

News that Goldman Sachs has withdrawn Fabrice Tourre's registration with the FSA here in London leaves a somewhat sour taste. All too often employees accused of wrong-doing are immediately put on leave as soon as the allegations by this or that regulatory body comes to light. This basically is an at least partial admission of guilt against which the individual has very little redress. It is a truly Kafkaesque situation were large organizations threaten the single person who of course is in a much weaker position than the people behind the bureaucracy. The irony is, that Goldman Sachs prides itself time and again for having a team approach in all it does - so it would be particularly strange that suddenly one single individual can be the only responsible party in such a substantial transaction involving prestigious 'clients'. In Tourre's case, for example, the FSA has no prima facie evidence itself, it just is hanging on the coattails of the SEC. If Goldman Sachs has any reason to suspend Touree is would beggar belief that no one else in the whole food-chain - possibly up to CEO Lloyd Blankfein - has been involved in the transaction(s) that are the subject of the SEC's case against Goldman Sachs (which incidentally is not a case just against Fabrice Tourre).

IMF - full of bureaucrats and tax dodgers

When the IMF bureaucrats call for more taxes on the banking system one can only feel a sense of revulsion. Not enough that politicians think they have to justify their existence by dreaming up a never-ending flood of regulations and spending plans, - but with them we at least have the consolation that they are subject to elections (far too irregularly though). The bureaucrats in the IMF (and similar international organisations, including the EU) face no such threat. They have secure tenure gilded by tax-free salaries. Naturally their instinct is to tax and spend other people's money, the socialist creed that keeps them in their jobs in the first place.

Disclosure no safeguard against deception

The more complicated the securities and investment businesses become, the longer are the legal disclaimers that pepper the front and back of related documents become. No wonder the 'leading' law firms now are located in what only can be described as palatial surroundings. The (mostly) impenetrable legalese is the equivalent of a mugger telling the victim to sign a document that absolves him from risk of persecution. In a sane business environment the law should be simple and not just a starting point for lawyers on their search for loopholes. Regulations should not leave any backdoor and the laws should be included in any transaction by implication. If, for example, a conflict exists between the recommendation to buy a security and the trading position of a broker-dealer it should either be (1) irrelevant or (2) prohibited. So to 'disclose' the conflict is either unnecessary in the first case or should not be an effective way out in case of claims for compensation in the latter case.

What is socially useful work?

Topical opportunity for Adair Turner, Chairman of the FSA here in London to clarify his exacting standards with respect to what is or is not 'socially useful work': is sitting on a sofa and 'reading' the breakfast news socially useful work? This is the question we ask ourselves as the BBC's Adrian Chiles is signed by ITV for a reported £6million.

Glass Steagall is good for you!

We continue to be amazed by the hysteric reaction of bankers to the possible introduction of a separation of business lines along the regulations imposed by the defunct Glass-Steagall Act of 1932 that separated commercial and investment banking for more than sixty years in the USA. Looking at it from another perspective - and not just short term/short sighted business perspectives - was the global success and dominance of the US investment banks not partially due to this enforced separation? Would the enterprise spirit not have been severely dented by keeping the entrepreneurial spirit constrained by the bureaucratic management structures of the commercial banks? A similar argument could be made in case of the City of London where the free-wheeling spirit of the financial community goes back over centuries and is in stark contrast to the top-down models of the continental European banking industry.

Dick Fuld's Ignorance: argument for smaller Banks

When the former CEO of Lehman Brothers argues that he had no knowledge of the bank's use of an accounting gimmick to hide its deteriorating financial situation we may well give him the benefit of the doubt in the absence of a 'smoking gun' proving the opposite. But it also demonstrates that even managing a financial firm such as Lehman Brothers was beyond the capability of one manager. Lehman did not have all the other business units that the typical 'Universal' Bank has under its wings (Credit Card, Consumer loans, Corporate Banking to name a few) and it still was possible that the man in command - and given his length of tenure he had the ability to know the shop inside out - did not get involved in substantial transactions such as the regular Repo 105 transactions which involved billions in balance sheet exposure. The argument that breaking up banks into smaller units would harm the economy holds no water. Why should lending to industry, and in particular to middle-sized and smaller businesses be harmed if a bank can no longer play in - to pick just one example - the structured retail client product market in Germany?

Goldman's CDO Investors - were they stupid?

The CDO product at the center of the SEC's case against Goldman Sachs raises the question: were the 'sophisticated' investors (including ironically the middleman Goldman Sachs) that bought into this transaction stupid or victims (or both)? Leaving the legal and factual arguments for the moment out of the discussion - what was the motivation that caused the fund managers at IKB and ABN Amro to buy securities that were one or two steps removed from any real underlying economic transaction? Speaking from experience I can see them as busy, maybe even diligent people who were working in a set of parameters that prevented them from questioning certain assumptions at the heart of the structured product business: that securitised products contain what the label promises, that companies with a certain public image behave in a way that confirms this image, that all players on the field can be trusted to pursue goals that do not harm the other participants.
Securitisation in particular is critically dependent on trust as the buyers in effect must give a certain amount of leeway to the creator of the product they are purchasing. The whole business idea underlying securitisation is the fact that the buyer does not want to - or is not able to - to buy the underlying assets himself. In effect, he buys a packaged product and can never expect to fully analyse all the assets - would he do so he could as well purchase these assets directly thus disposing of the need for securitisation.

Betting on my neighbours house?

Lynn Stout's point about Goldman Sachs' Abacus Mortgage Derivatives Deal (New York Times) illustrates the need for stricter derivatives regulation:

"...much of the blame for investors’ losses in the Abacus deal can be laid at the feet of an obscure statute passed by Congress in 2000, the “Commodities Futures Modernization Act.”
If we allow the unscrupulous to buy fire insurance on other people’s houses, the incidence of arson would rise sharply. In one dramatic move, that act eliminated a longstanding legal rule that deemed derivatives bets made outside regulated exchanges to be legally enforceable only if one of the parties to the bet was hedging against a pre-existing risk."

Derivative Trading can be moved to Exchanges

While it has to be accepted that not all derivatives can be traded as standardised products the overwhelming majority could be accommodated on exchanges if a few simple modifications were made: in particular, the available expiration dates have to be frequent enough (monthly series) so that most requirements can be handled. Does a corporation really need to hedge interest rate risk to a date outside the available expiration cycles? We do not think that is necessary in the majority of cases. With sufficient incentive (different capital and accounting treatment in favor of listed derivatives) most companies would choose standard contracts. Concentration of activity in listed exchanges would create a tremendous increase in liquidity and this - in addition to much higher transparency in pricing - would lead to a snowball effect in favor of listed products. Would clearing houses be able to accommodate the rise in volume and consequent rise in risk in case one party should fail? This certainly could be a problem but at least the problem would be out in the open and not hidden in the (off)balance sheets of banks (usually in the footnotes). There they are posing the same level of risk but it is clear that the only guarantee in case of a failure of a counter party is the (implicit) guarantee by the taxpayer. A clearing system has to be designed to be robust enough to withstand any conceivable failure. This means sufficient margin collateral. 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.

P.S.: Today's article in The Times about disputed valuations concerning the sale of Lehman-related derivatives during a margin call illustrates that trading of derivatives on exchanges would create a more transparent pricing system.

Bruce Wasserstein: danger of star culture

Vanity Fair's portrait of Bruce Wasserstein confirms our long-standing suspicion that he was a brilliant deal maker - for himself. The 'bid them up' method of merger 'advice', the sale of his firm to a naive Dresdner Bank and his rapid departure afterwards should be a warning for any firm that tries to build its business on the shoulders of 'stars'.  It also illustrates the Peter Principle as most organisations have their share of senior managers who have outlived their usefulness.  In this respect it is curious that a large new office is constructed for Felix Rohatyn who is about to return to Lazard as a senior advisor. This brings back memories of another new office for a senior official in the dying days of the old Merrill Lynch. Could one say there is a 'New Office Syndrome' where a big ego needs a big office to feel safe and secure in its position?

Private Equity burns its fingers with BAWAG-PSK

News that the value of the stake in Austria's BAWAG-PSK bank that the private equity fund Cerberus bought in conjunction with an investor group may only be worth a quarter of the purchase price makes sobering reading. It demonstrates that overpriced acquisitions are not only the consequence of muddled thinking by the managements of established banks but can also lead the hard-nosed managers of private equity funds astray. While traditional managers are often seduced by the excitement of the hunt the fund managers may be pressurised by the need to put to work the money they have collected in the fund.   

How to control Commercial Property Lending

A report by the US Congressional Oversight Panel states that more than half of all outstanding commercial property loans are larger than the value of the underlying property highlight the need to reign in the banking system's freedom with respect to lending to commercial property. The report prompted us to submit the following comment to the Committee:

One often has to wonder how individual 'developers' can amass huge fortunes when most of them never had a shovel in their hand. A quick glance at the list of Billionaires in the Forbes list confirms that property development (and speculation) is an extremely profitable business for the few. A lot of this apparent success is due to the endless inflationary spiral during the post-war years, some is due to entrepreneurial spirit - but a lot is also due to lax lending practices (sometimes aided by dubious practices, the least pernicious being free tickets to sports events and meals in lavish restaurants provided to loan officers).
Reform should put strict limits on the loan value of any commercial property. At the same time 'interest only' loans should also be put under the spotlight. If they are deemed to be too risky for private homeowners they are even more risky in the hands of professional speculators and cannot be allowed to put the banking system under undue risk.

Risks - Higher rates and Creditor strike

All the financial and economic geniuses teaching Finance have forgotten that credit depends to a large extent on trust (lat. credere, to believe, trust in). Banks relying on buying in deposits, companies rolling over their commercial paper on a daily basis, countries buying off their voters with ever-increasing levels of borrowing all have to face the fact that when the music stops there might not be a chair left for them in the frantic scramble to replace maturing funds.
It is even more laughable to hear that Greece  claims (supported by many 'experts') that it cannot afford to pay interest rates of 6.5 or 7 per cent. I only can say, get real guys! Rates have been in double digits in the past few decades, and anyone thinking that this cannot happen again better wake up before it is too late. Interest rates do not have to reach extreme levels, but anything in the 5-7 per cent range, with a possible overshoot towards 8 or 9 per cent is in the realm of the possible. I used to say (well before the credit crunch!) that hardly anyone was prepared for a sudden shift in asset prices by 20 per cent. Little did I know that that was a conservative estimate in view what happened during 2007/09. Now I would warn all debtors to plan for higher rates.

Deutsche Bank puts $500 million into new Hedge Fund

It would be interesting to know if Deutsche Bank invests for its own account or its clients. If the former one wonders how that fits in with designs to de-risk the banking system and limit proprietary activities?

Can trust in Securitizations be revived?

The discussion about the feasibility of reviving the securitization business revolves to a large extent about how to ensure that investors can trust the integrity of the packaging process that is behind the creation of the securities backed by the underlying loans and mortgages. The concept of securitization from the buyer's perspective means that as an investor he gets access to a multitude of loans that are individually too small to be of interest (in the case of the institutional buyer) or too large (for a small retail investor). Both are unwilling or unable to conduct individual due diligence on every single underlying loan and in effect have contracted out the credit research to the institution that creates the loan bundle they are acquiring. 
While in an ideal world the 'free market' would take care of the problem of moral hazard and ensure that no loans of questionable value are sold or purchased we do agree that the requirement for packagers to retain a substantial stake in the securitized product is a sensible suggestion. While this may well raise to cost of the securitized package we think this is a price worth paying given the abuses that helped create the credit crunch of 2007-09.

Compensation vital cost factor

Over the years we have observed the rise and (more frequently) decline of many investment banks. As compensation is the key cost factor in the industry a sensible compensation structure is essential to achieving long-term success in the business. So when we read that the centuries-old private bank of Sal. Oppenheim had agreed to pay a former chief executive of Arcandor the princely sum of 4 million Euro a year for being an advisor (and on top of it give him a three-year contract) we were not surprised that the company had to be sold to Deutsche Bank. To throw around money like a drunken sailor can only end up with the business withering away due to lack of profitability. The situation at Lehman Brothers (and the old UBS before it was swallowed by Swiss Bank Corporation) was not dissimilar. The level of compensation was completely out of whack and while it may not have been the deciding factor in the demise of these enterprises it certainly was symptomatic for a general lack of good management and governance. Sensible recruiting is one - if not the - key factor in the success of a people business like investment banking - as well as in banking, securities brokerage and investment management. 

Global Banks need Global Regulation

The collapse of Lehman Brothers which had nearly 900 subsidiaries in around 20 jurisdictions demonstrates that financial institutions that want to be active on a global basis also need to be regulated on a global basis. The alternative has to be that each subsidiary is regulated on a watertight national basis (with its own capital requirements). Politicians and Regulators have to give a clear-cut response to the question what would happen if a globally-active bank with large operations in several countries gets into serious difficulties. As banks spread their wings wider and wider - see Banco Santander and Unicredit for example - an answer to this question becomes more and more urgent. Can their clients rely on the backing of their home country or is the government of the host country expected to write a blank cheque if the worst should happen? The case of the Icelandic banks should have been a wake-up call.