Indy Telecom & Industrial Media

FT had an interesting piece written by the former Treasury Secretary Henry Paulson on reforming the architecture of regulation.

As Paul Kedrosky so rightfully observes, the most interesting aspect of the article is how seems to be asking for “ample and flexible authority” for the FDIC to deal with failing banks (through the Treasury and the Fed, of course).

I notice all the buzzwords (moral hazard, risk management etc); but what does scare me are the phrases “explicit federal authority” and “power” and “exigent circumstances”.

But of course.

Two great pieces by the wonderful folks at PIMCO -

•  Hairy Lips Sink Ships by Bill Gross
  
• Saving Capitalistic Banking From Itself by Paul McCulley

(via Paul Kedrosky)

It was bound to eventually happen, given the hue and cry over bonuses. And so it did.

Today, UBS announced what they call “Maluses” where previously earned bonuses will be forfeited if they underperform.

Just as bonuses (Latin for “good”) are paid out for good performance, maluses (“bad”) will be meted out if the bank subsequently makes losses or if the employee misses performance targets, UBS said. The maluses could wipe out all previously agreed share bonuses and two thirds of all cash bonuses under stringent new rules designed to align the interests of executives and traders with those of shareholders.

So, can we also extend this to the salaries of people, as well? After all, if you have to give up your bonuses when you underperform, why not give up your salaries and promotions when you underperform, as well?

Something tells me that this is not a good precedent — nevertheless, I see a lot of cheering from the sidelines for this move, unfortunately.

Paul Kedrosky talked about a blog post on Tired Fools, which talks about how in The Annals of Imperial Rome, Tacitus describes the credit crunch in ancient Rome, complete with property slump and government bailout –

Accusers were now intesely active. Their present targets were men who enriched themselves by usury, infringing laws by which the dictator Julius Ceasar had controlled loans and land-ownership in Italy. Since patriotism comes second to private profits, this law had long been ignored. Money-lending is an ancient problem in Rome, and a frequent cause of disharmony and disorder. Even in an earlier, less currupt society steps had been taken against it. At first, interest had been determined arbitrarily by the rich, but then the Twelve Tables had fixed the maximum at 10 per cent. Next, a tribune’s law had halved the rate. Finally loans on compound interest were forbidden completely. Fraudulence, attacked by repeated legislation, was ingeniously revived after each successive counter-measure.

Now, however, the praetor Sempronius Gracchus, responsible for the investigation, was compelled by the numbers of potential defendants to refer the matter to the senate. That body – being implicated to a man – nervously entreated the emporer’s indulgence. It was granted. Eighteen months were allowed in which all private finances had to be brought into line with the law. The result was a shortage of money. For all debts were called in simultaneously, and the numerous convictions and sales of confiscated property had concentrated currency in the Treasury and its imperially controlled branches. To meet this situation the senate had instructed that creditors should invest two-thirds of their capital in Italy, and debtors immediately pay the same proportion of their debts.

However, creditors demanded payment in full, and debtors were morally bound to respond. The first results were importunate appeals to money-lenders. Next, the praetors’s court resounded with activity. The decree requiring land purchase and sales, envisaged as relief, had the opposite effect since when the capitalists received payment they hoarded it, to buy land at their convenience. These extensive transactions reduced prices. but large-scale debtors found it difficult to sell; so many of them were ejected from their properties, and lost not only their estates but their rank and reputation.

Then Tiberius came to the rescue. He distributed a hundred million sesterces among specially established banks, for interest-free three year state loans, against security of double the value in landed property. Credit was thus restored; and gradually private lenders, too, reappeared. However, land transactions failed to adhere to the provisions of the senatorial decree. As usual, the beginning was strict, the sequel slack.

On that note, it is rather interesting to look at the fall of the Medici bankers. Forbes recently had an article on the Medici meltdown, which talked about how the Medician crash was caused by warfare and misappropriation of funds, resulting in a rather large credit crunch -

“The fear of being annihilated by foreign powers, combined with the lack of transparency, allowed the ruler of the Republic to turn it into an effective tyranny. With the declared purpose of defending Florentine freedom and its way of life, Lorenzo raised taxes for the war and embezzled banking funds with the result (does this sound familiar, anyone?) of creating a huge credit crunch.

“The Medici Bank… had tenuous cash reserves that were usually well below 10% of total assets. Lack of liquidity was an issue for banking since its origins. Of course, in the Renaissance they dealt with thousands or millions of florins–billions were yet unthinkable. But would a bailout have been thinkable at the time? Lorenzo certainly bailed himself and his family out of a political and financial mess with public funds. He eventually gained for himself the superlative epithet of “The Magnificent” by obtaining fforeign military support and by compromising his city’s liberty.”

It is amazing how some things never change; they only get amplified, for better or worse. Perhaps, it would be worth a reminder that history doth repeat itself.

The MIT Classics Archive has the Annals of Tacitus, and the Gutenberg project has The Reign of Tiberius, Out of the First Six Annals of Tacitus; With His Account of Germany, and Life of Agricola.

So, I was off by a few weeks.

Bite me.

I’ve been meaning to write about this for the longest time. While the state of the American economy is of much concern, the current state of affairs in the Europe makes our problems look like a walk in the park.

The fundamental problem in Europe has been the attempt at consolidating disparate economic systems and values into a single source, thanks to the Euro. While this has had some success when things were going well, it would seem that this is not particularly true when things are going badly.

This is also complicated by the political climate in the constituent countries and of course, the display of absolute maturity over silly rivalries (because all those Saxons, Anglo Saxons and Vikings are *oh-so-different*).

But there is a deeper issue here. And that is that while the American financial system has been mismanaged, that does not compared to the way Europeans have mangled theirs.

Paul Kedrosky recently had a post on How the US Saved the European Banking System.  In his post, he quotes a short report by Daniel Gros & Stefano Micossi that provides an interesting little table (The beginning of the end game [PDF]).

And to give you an idea of the leverage issues, Lehman had a leverage of 24 (gross, of course — net leverage ratio was 12, which is debt-times-equity).

Goldman keeps its leverage trimmed at around 17-22 (depending on the time of the day and market conditions, of course). Of course, Goldman’s leverage has also been more sustainable in general because Goldman hasn’t needed to borrow as much as its competitors.

The other factor is even more scary. And that is the asset valuation of the financial institutions relative to the GDP of their host nations.

To make it worse, countries are worried about pooling money to help banks in other countries within the EU when their own institutions are struggling. And can you really blame them? This, more than anything, calls into question the sustainability of Euro as a currency.

The other thing that I’ve heard from my friends in the industry is that certain European banking laws give banks the option of not disclosing certain pieces of information that are necessary for banks in other countries. This, of course, makes it hard to estimate the exact financial health of these institutions.

So, given these facts, is it any wonder that European banks and governments are scared? For example, the whole exchange between UK and Iceland seems childish (a friend called it Britain’s revenge for the Viking invasion of 400 800 A.D.). But then, people do funny things when they are scared.

So, Euro death watch, anyone?

How long until DJIA goes below the 10,000 mark?

After hours trading is killing the market. I predict that immaterial of what happens, within the next few days, a few regional banks will either go down or get bought.

My eye is on National City and Fifth Third. Let us see.

Update: Turns out that I am not alone, not after a 52% fall.

Goldman Sachs and Morgan Stanley have asked for and been approved the bid to become banks, marking the end of the investment banking era on Wall Street.

The more interesting part is that in the past couple of months, every weekend has been mired with some eventful occurrence or the other, on Wall Street. That said, this is indeed a sad day when all the major i-banks have either gone under, been bought out by bigger, regular commercial banks or have elected to become commercial banks.

Goldman, the largest and most profitable of the U.S. securities firms, will become the fourth-largest bank holding company. The firm already has more than $20 billion in customer deposits in two subsidiaries and is creating a new one, GS Bank USA, that will have more than $150 billion of assets, making it one of the 10 largest banks in the U.S., the firm said in a statement last night. The firm will increase its deposit base “through acquisitions and organically,” Goldman said in a statement last night.

The change is also likely to lead to less risk-taking by the companies and possibly lower pay for their employees. Both Goldman and Morgan Stanley held more than $20 of assets for every $1 of shareholder equity, making them dependent on market funding to operate.

While I am not sure if that is entirely a good thing, market sentiment is what market sentiment is. Either way, Wall Street won’t quite be the same again.

My tailor has a quote that says something along the lines of dressing for the job you want, unless you are an investment banker – I guess that wouldn’t be holding true for much longer.

Quote of the week, by Akshay:

 ”…and while we’ve been out, intimate, with our respective petites amies, Merril Lynch and Lehman Brothers have collapsed.”

So, the awesome folks at Dealbreaker have posted two equity research reports by Oppenheimer that talk about the current valuations of US banks (Oppenheimer Note-US Banks and Oppenheimer-US Bank Slide Show). The crux of the reports is that for the current financial markets to stabilize, valuations need to be address “true asset values” and get back to adjusting their books to that effect (and for whatever reason, this is stated oh-so-many-times in both the documents).

Not that I disagree with the fundamental premise of the reports, but one thing is that while fundamentals are certainly very crucial, a lot of valuation is also driven by sentiments. This is particularly true in banking, and one but need look at Bear Stearns (and currently, Lehman) to understand this.

And as far as liquidity is concerned, the economy is quite flushed with money, thanks to our wonderful Fed (and Uncle Benny).  It would be hard not to be, given the current rates of inflation and interest rates. That is not the problem. The problem is that the current market sentiment is driving folks towards more and more liquidations, and a lot of it is used to hedge against what the market perceives to be a free fall.

Quite obviously, this is compounded by increasing oil prices; however, oil is also heavily driven by market sentiment. As a result, we are seeing a rise in what is otherwise quite an inelastic market. Eventually, however, this is already beginning to have impact on oil consumption, which could potentially drive oil prices down.

That said, it is also quite possible that oil producing economies could cut supply to ensure that prices stay high. I would think that this would be beneficial to them on one hand; however, given increasing inflation concerns and low consumption, it might not be in their best interest to do so.

Here are some interesting links that I’ve been meaning to post for a while –

• Old-School Economics: An interesting article on the NYT on the current recession stagflation.
• Anti-bubble: What’s up with all these attempts to coin weird sounding terms, anyway?
• It’s not over until the fat lady sings.

Last week, it was revealed that a “rogue trader” named Jérôme Kerviel working at the French bank Société Générale managed to supposedly cause a loss of $7.2 billion (€4.9 billion) for the bank.

Now, while it is quite possible that Kerviel was far from innocent, it is not easy to believe that a single trader, who apparently had very limited authority and handled back and middle-office work could have lasted this long unnoticed while playing with billions.

If he’s caused a loss of ~€5 billion on the futures market, it is quite likely that the exposure of his positions were quite possibly ten times that amount — i.e €50 billion — or more. That’s half the total capitalization of the bank. It is disturbing to hear that a small trader who is a nobody could gamble with such large sums and go unnoticed.

Even worse is SG’s claim that Kerviel did this with no person gain for himself. It could be that like all rogue traders, all Kerviel wanted to do was to hide his losses, and if he had recovered from them, nobody would have heard of him. And it is quite possible that since Kerviel does do back-office work, he could have taken positions and verified them himself, for his own orders. That is believable if Kerviel were known to be either a financial or a computing whizkid, neither of which seems to fit his profile. So, it is very likely that he had at least one accomplice to help him along — which contradicts SG’s claim that he was supposedly working all alone.

Now, I’ve read another theory which seems a lot more interesting. SG probably has more losses than it lets up, and what better way to get it all written up than to find a fall guy and blame it on him? Once you do this, you can simply ask for an increase in capital and you are suddenly a very attractive buy-out/merger target.

Besides, who cares about accountability when you can have other banks pull you out in the spirit of camaraderie, right?

To quote the poster Rocket –

Sink the damn bank. We’ll find a fall guy and then call for a capital increase and now the bank becomes even more attractive to French banks because of it’s low price. Thus you create a monster like BNP-SOCGEN and France conquers the banking world with another giant.

SOCGEN didn’t need to increase their capital. They could have absorbed the loss in 2 years with the profits they make, so something is rotten in Paris. This is unheard of a company increasing their capital 5 minutes after they discover a “fraud”

This way. French banks keep one of their own and another French giant is artificially created “de toute piece”

In the past France manipulated the free market and competition through subsidies and Monopolies today it is through stinking financial “montages” “Liberation de la croissance” will be reduced to increasing the number of taxis. It sounds so phony. The good ol’ boys are all in it together.

I now understand why the French are nostalgic for Marxism with the kind of gutter capitalism they practice.

These guys make Nick Leeson look like an amateur.

A quick look at the market the past few days would suggest that the banks and other financial institutions are having a particularly bad time. Most of it is the remnant effect of the sub-prime mortgage tomfoolery that everybody happily part-took in, but the other half is the serious credit crunch that’s been going on in the market.

And of course, a lot of this originated from the fact that these guys decided to sell asset-backed securities when their very assets were in question. So, our beloved (I use that term very loosely, of course) treasury department decides that that is not a good thing.

What do these guys do? Citi, JP Morgan Chase and Bank of America decide to come together and build a $100 billion Structured Investment Vehicle backed by – get this – more asset backed commercial paper. Heh.

Quite aptly, the folks at Dealbreaker have termed this “master” SIV as The Entity.