That most authoritative of news sources, the Daily Mash, has drawn their own conclusions from the HBOS report:
A DAMNING report into former bank bosses has raised the question of whether anyone should be allowed to work in finance.
As the banking standards commission suggested three former HBOS directors should be banned from the industry, experts said the men had been greedy and very bad at their jobs, just like absolutely everyone else who does this kind of thing.
Julian Cook, chief economist at Donnelly-McPartlin, said: “Acres of empty office space. You may as well graze sheep at the foot of the Shard.
I think this is a very bad idea. The Shard is tall, and it will block the sheeps’ light, leading to depressed baa-lambs. Grazing sheep at the top of the Shard is a much better idea.
From the Parliamentary Commission on Banking Standards report into the collapse of HBOS:
A huge amount of regulatory time and attention, in relation to HBOS as with other banks, was devoted to the Basel II model approval process… HBOS attached importance to obtaining the so-called ‘advanced status’, because it would potentially enable them to hold a lower level of regulatory capital.
The HBOS application was then granted in September 2007, subject to conditions that needed to be satisfied by 1 January 2008. Michael Foot (the FSA Managing Director for Deposit Takers and Markets 1998-2004) described Basel II as “immensely complex and immensely resource demanding” and “a complete waste of time”…
From 2004 until the latter part of 2007 the FSA was not so much the dog that did not bark as a dog barking up the wrong tree. The requirements of the Basel II framework not only weakened controls on capital adequacy by allowing banks to calculate their own risk-weightings, but they also distracted supervisors from concerns about liquidity and credit; they may also have contributed to the appalling supervisory neglect of asset quality.
The bankruptcy trustee’s report into MF Global is out, and Louis Freeh has done an interesting job. It comes close to saying that there is a case against Corzine, without actually stepping over the line. Here’s one of the punchlines:
The negligent conduct identified in this Report foreseeably contributed to MF Global’s collapse and the Debtors’ subsequent bankruptcyfilings. Although a difficult economic climate and other factors may have accelerated the Company’s failure, the risky business strategy engineered and executed by Corzine and other officers and their failure to improve the Company’s inadequate systems and procedures so that the Company could accommodate that business strategy contributed to the Company’s collapse during the last week of October 2011.
It will be interesting to see how this one plays out.
Noahpinion has an interesting post on the variety of equilibria in economics:
Walrasian equilibrium, also called “competitive equilibrium” or sometimes “general equilibrium”, is basically when prices adjust so that all markets clear…
A Nash equilibrium is when people’s strategies are best responses to each other – in other words, when no one would choose to change their plans if everyone else’s plans stayed fixed…
A Rational Expectations Equilibrium (REE) is a kind of Walrasian equilibrium with uncertainty about the future. In addition to the condition that prices adjust to clear markets, a REE includes the condition that people’s subjective beliefs about the probability of future events are equal to the actual probabilities of those future events.
What if prices can’t adjust to clear markets? … In that case, markets might not clear, so you wouldn’t have a Walrasian equilibrium. BUT, you’d still have people’s plans being consistent with each other. In this case, you’d have the kind of equilibrium in a sticky-price New Keynesian macro model, in which labor markets don’t always clear.
In most dynamic models (for example, DSGE models), the economy tends toward some “steady state”, in which either nothing in the economy is changing, or in which things are only changing at constant long-term trend rates.
What’s interesting, I think, is how rare these are in practice. You do get Walrasian equilibria in financial markets with price transparency, informed agents, and highly fungible goods. The others, though, are theoretically nice but in practice rare, not least because the forcing – external event – happens more frequently than the relaxation time (the time to get close to equilibria). And because agents aren’t rational, and don’t plan…
So say the CFTC, according to Bloomberg:
Commissioners approved a rule excluding inter-affiliate trades from requirements that swaps be guaranteed at clearinghouses that protect buyers and sellers against defaults, the CFTC said yesterday.. “The rule requires documentation of such exempted swaps, centralized risk management and reporting requirements for such swaps,” CFTC Chairman Gary Gensler said in a statement.
No, not other clearing post: this is about forms of transport.
Consider the data to the right about the composition of traffic at a central London junction in peak hours from Cyclists in the City. This seems to be a reasonably even balance until you consider the space occupied by each form of traffic vs. the number of people carried. Using reasonably estimates of bus and car occupancy, we can work out the impact, in terms of road space saved per person, of banning each form of trafffic.
The results of that are pretty unequivocal. If we need more space on the roads in central London, ban HGVs or cars or both. And boy, do we need more space. After a mild improvement in the early days of the congestion charge, traffic speeds are roughly the same as a chicken. We need to reduce traffic and, objectively, the best way to do this is to remove cars and lorries from the road.
Interestingly the Dutch have realised this. Amsterdam’s new traffic plan proposes segregated routes for bicycles (green lines), buses/trams (blue), and cars (red). The map illustrates the plan: in the yellow area, pedestrians have priority; over that area and much of the rest, different modes of transport are segregated, with motorists not being allowed near the centre. This is a much fairer, safer, and more environmentally friendly solution than shared roads.
Now London’s problem is bigger than Amsterdam’s (not just in congestion terms, bad though that is: air quality is a bigger issue here), so we will have to be more radical. Here’s what I suggest:
I have endured a couple of talks recently on the use of network methods in financial stability analysis. While the general idea is interesting, the specific applications struck me as dubious in the extreme. So it was with some relief that I read something about robustness that was useful and impressive – albeit with no finance connection. Science Daily reports:
a team of engineers at the California Institute of Technology (Caltech)… wanted to give integrated-circuit chips a healing ability akin to that of our own immune system — something capable of detecting and quickly responding to any number of possible assaults in order to keep the larger system working optimally. The power amplifier they devised employs a multitude of robust, on-chip sensors that monitor temperature, current, voltage, and power. The information from those sensors feeds into a custom-made ASIC unit on the same chip… [This] brain analyzes the amplifier’s overall performance and determines if it needs to adjust any of the system’s actuators…
[The ASIC] does not operate based on algorithms that know how to respond to every possible scenario. Instead, it draws conclusions based on the aggregate response of the sensors. “You tell the chip the results you want and let it figure out how to produce those results,” says Steven Bowers… “The challenge is that there are more than 100,000 transistors on each chip. We don’t know all of the different things that might go wrong, and we don’t need to. We have designed the system in a general enough way that it finds the optimum state for all of the actuators in any situation without external intervention.”
Reuters, in between telling a interesting story of the impact of Kweku Adoboli’s losses on UBS, gives us some insightful information on the close out of his position:
The call that would eventually spell the end for [UBS boss Oswald] Gruebel came at 4 p.m. on Wednesday, September 14… [Gruebel] ordered a small taskforce — dubbed “Project Bronze” by those involved — to immediately close Adoboli’s open positions…
The Swiss stock exchange had to be informed by 7.30 a.m. With two-thirds of Adoboli’s open positions closed out overnight, the scale of the losses was clear and executives agreed they would have to say something…
Bankers said Adoboli’s positions were completely closed out by Friday lunchtime.
That would be a little less than two days, then, to get out of exchange traded positions (including ETFs).
Lehman Brothers Holdings Inc said on Wednesday it plans to distribute about $14.2 billion to creditors early next month… [this] will increase total distributions to about $47.2 billion, with two-thirds going to third parties.
The company has said it hopes to distribute more than $65 billion, on average about 21 cents on the dollar for allowed claims…
Following the distribution, holders of senior unsecured claims against the parent company will have received about 14.8 cents on the dollar on their claims
So, five years on, more or less, we are up to 15% recovery, with 20% in sight. Hmmm.
There has been a lot of negative comment about the Cyprus deal. That is understandable: you can reasonably argue that it will produce crippling austerity; that it is ridden with moral hazard; that it will create a bank run across most of Southern Europe. But what you can’t argue is that it was unexpected. After all, as Sony Kapoor points out, the standard template for bank resolution calls for bond holder and, if needed, uninsured depositor bail in together with liquidity assistance from the money printer. We got what was planned. If the plan isn’t a good one, there are bigger issues than Cyprus that we need to address.
From the new Basel consultative document BCBS 245:
Credit protection costs will be considered material when the risk weight on the exposure in the
absence of credit protection would otherwise be greater than 150% at the time the credit protection is bought…
A bank must calculate the present value of material credit protection costs … if such costs have not been recognised in earnings … The present value should be treated as an exposure of the bank and be assigned a 1250% risk weight.
I don’t see that this really helps that much, as you can always mix in ‘good’ stuff to lower the risk weight below 150% and so be out of scope of the rule.
I pushed the scanner hard on this one; it worked out reasonably well though I think. The mist gives a nicely smudgy quality to it.
Jon, posting at the OTC space, does a nice job of setting out the size of various markets. In particular he uses gross market value rather than notional for OTCs, which is a (much) more useful measure. The results are interesting:
||Market Size ($T)
This makes one wonder about quite a lot of policy direction: to pick one example from many, shouldn’t there be a loan trade repository?
Continuing the OTC derivatives futurisation trend, ICE announced this week that it will introduce credit index futures in May on the CDX IG, CDX HY, iTraxx main and iTraxx cross-over. Anyone care to take a bet on how much volume will be in futurised swaps vs. cleared OTCs this time next year?
An interesting idea, this, from Acemoglu and Robinson. They say
Our basic argument is simple: the extant political equilibrium may not be independent of the market failure; indeed it may critically rest upon it. Faced with a trade union exercising monopoly power and raising the wages of its members, most economists would advocate removing or limiting the union’s ability to exercise this monopoly power, and this is certainly the right policy in some circumstances*. But unions do not just influence the way the labor market functions; they also have important implications for the political system… Because the higher wages that unions generate for their members are one of the main reasons why people join unions, reducing
their market power is likely to foster de-unionization. But this may, by further strengthening groups and interests that were already dominant in society, also change the political equilibrium in a direction involving greater effciency losses. This case illustrates a more general conclusion, which is the heart of our argument: even when it is possible, removing a market failure need not improve the allocation of resources because of its impact on future political equilibria.
*Where by ‘some’, I hope the authors mean ‘very few’.
Many big banks have now had large operational risk-related events in the last few years, notably litigation related (think for instance of the PPI settlements in the UK or the mortgage ones in the US). What has that done to the banks’ operational risk capital models I wonder? You would have thought that having those large losses in the modeled distribution fattened out the tails no end…
Update Opdyke and Cavallo say:
…certain types of events are “industry” events that occur at multiple institutions in the same general time period, such as the wave of legal settlements related to allegations of mutual fund market timing. An institution that itself incurred one or more such losses may be justified in excluding other institutions’ losses (if they can be identified in the external data) since that specific industry event is already represented by an internal loss in the bank’s loss data base.
That is reasonable. What is less so is ignoring your own loss, taking the industry wide loss from some database and dividing it by the number of banks contributing towards the database. That has the effect of softening the loss considerably. Mind you, give what BofA for instance has paid out in mortgage related litigation, without that kind of approach its op risk capital requirement at 99.9% confidence under the AMA (were that to be the standard, which, right now, it isn’t in the US) would surely be more than the capital it has…
This is definitely in Caspar David Friedrich territory.
Update. Talking of being out in the cold, the Cyprus depositor bail in is generating a lot of comment this morning. The general view seems to be that haircutting uninsured deposits, while painful, would be reasonable; but the current proposal to also haircut insured deposits is a bank run generator. I tend to agree, but it seems that the former was the IMF position, while the latter was chosen by the Cypriots themselves (HT Coppola Comment for the link). Even if that is true, it’s dreadful policy. As Tim Duy says, it is hard to see the assault on Cypriot depositors as anything but a step backwards for financial stability in Europe.
It seems that JPMorgan’s travails have become a spectator sport, to be enjoyed with a snack of your choice. I am only half way through the senate report, let along the appendices, so I won’t add to the (already comprehensive) guides to the action‡.
Instead I want to focus on four key issues which emerge from this debacle.
- CIO wasn’t hedging. Like Matt Levine, I had bought the firm’s line that the original portfolio was a macro hedge against the loan book. It is now clear that while that might, in the mists of time, have been the original motivation, the CIO’s office had turned into a prop trading center by 2012. This happened without, as far as I can tell, any authorisation, any redesign of the risk framework, or any changes in oversight. Mind you, given that the risk framework was not based on how well they were hedging anyway, that is hardly a surprise.
The Machiavellian analysis of this is that they were trying to prop trade while avoiding Volcker. My gut feeling is that it wasn’t that: they were simply out of control.
- As Lisa says, mis-marking is key here. The practice whereby, in complete violation of what the accounting standard actually says, US banks are permitted to mark derivatives anywhere between bid and offer must now receive attention. Supervisors must ensure that firms mark at where they can exit the position as it is absolutely clear that external auditors cannot be relied upon to police valuation practice.
- My earlier conjecture that capital management was central to the whale losses is born out. But it is worse than I thought: capital optimisation was mostly about changing the model so that it generated lower numbers. This was wholly cynical, and is bound to increase the pressure to reduce the capital benefit available from the use of internal models§.
- While JP undoubtedly kept things from the OCC, the OCC’s process allowed JP to make model changes without sufficient oversight, did not exercise control over valuation practices, and had little idea what was going on in the CIO. After all, the story was broken by journalists based on public information.
While all the focus so far has been on JP’s mis-deeds, JP’s supervisors do not emerge from this covered in roses.
It will be interesting to see if the Senate can keep up the (encouragingly bipartisan) momentum here. One is uncomfortably aware that a confrontation may be brewing with politicians and public on one side, and the big banks, the OCC, and perhaps the FED on the other. If it really does pan out that way, the legitimacy of current regulatory arrangements may not survive the fall-out.
*The reference is to an extraordinary radio interview that Paul Roy, ex-head of equities at Merrill, gave about the old days on the London Stock Exchange, in which he claimed his equity traders used to enjoy a glass of madeira, or perhaps champagne, as a mid-afternoon pick-me-up. O Tempora, O Mores.
‡See also here and here. One delicate point, by the way, which I have not seen anyone really pick up on, is what ‘lag’ means in the transcripts. It seems to mean the time between general economic improvements affecting the HY vs. the IG indices, but it could also mean the difference between it affecting the spread of the components vs. the index itself. Given that JP’s opponents where hedging mostly using the components, JP was very exposed to the index/components basis.
§See the recent speech from Stefan Ingves here. Ingves says that “Major [Basel Committee] projects currently under way include: … completing the review of the trading book capital requirements. This entails an evaluation of the design of the market risk regulatory regime as well as weaknesses in risk measurement under the framework’s internal models based and standardised approaches.”
There has been a blog-fight between Bloomberg, whose editorial suggested that large US banks enjoy an 80 bps funding subsidy from the tax payer, and Matt Levine, who came to, well, a lower number. Now, I don’t really have a dog in this fight, but I was amused to note that SIFMA, a trade association, quoting the IMF, came to a 20bps subsidy.
Let’s assume that the subsidy is indeed 20 bps, and moreover that that 20 applies just to non-deposit funding. We will take JPMorgan, as that seems to be the paradigmatic example. JP has roughly speaking $2.4T of assets, funded by $1.2T of deposits, $200B of shareholder’s funds, and $1T of debt (quite a bit of it short term). So suppose JP enjoys a 20bps subsidy on that $1T*. That comes to $2B. Two billion dollars. To put this number in context, JPM’s last dividend payment was roughly $1.1B (30 cents a share last quarter to 3.8B shares). So the annual state subsidy JP gets, using trade association numbers, covers 40% of what JP gives shareholders. Um. I don’t know about you, but if this is even vaguely plausible, then the US taxpayer could legitimately be quite peeved about it‡.
*Obviously the 20 is a blended number; it won’t apply equally to all maturities of debt, nor equally to secured vs. unsecured funding.
‡For an earlier discussion of the UK taxpayer, see here.
First, IntercontinentalExchange said it will launch credit-default swap futures in May.
Second (and as an update from an earlier version of this post), Bloomberg threatened to sue the CFTC unless it halts regulations setting higher collateral standards for swaps than comparable futures:
Bloomberg LP, the parent company of Bloomberg News, said the collateral rules are arbitrary and harm its plans to operate a swap-execution facility, according to a news release and letter yesterday from Eugene Scalia, partner at Gibson Dunn & Crutcher LLP.
Swaps that are converted to futures will “automatically be subject to a lower minimum liquidation time, which in turn will result in more favorable margin treatment,” Scalia said in the letter to the Commodity Futures Trading Commission. The different standards will drive business away from Bloomberg’s swap-execution facility, Scalia said.
The CFTC should stay the regulations, which set a five-day liquidation requirement for financial swaps compared with a one- day period for futures, Scalia said. He requested a response from the CFTC by March 19.
The CFTC has announced that mandatory clearing begins today
(well actually yesterday as I am out of town and got to this a day late).
The requirement applies to new and notated swaps which fall within the CFTC’s clearing mandate.
Mortgage backed securities began with pass throughs; these were simply bundles of mortgages in security form. The PT did what it said on the can, passing through payments on the underlying mortgages to the security owner, perhaps after a servicing fee has been taken. Only later did trenching come to the MBS market.
Now, it seems, pass throughs are coming to the corporate loan market. In particular, some European banks are trying to develop a repo market in corporate loan PTs. Nothing has, I understand, been done yet but the ambition is there.
Perhaps some of the lessons of the CDO market have been learned: certainly a PT with full transparency over the underlying loans is simpler than a tranche of a high grade CDO, especially a managed one. But nevertheless this is shadow banking, and one might worry about the procyclicality of haircuts.
The RBS 2011 annual review lists (roughly*) eight business lines:
- UK Retail, comprising NatWest and RBS retail
- UK Corporate
- Wealth, which is mostly Coutts and offshore NatWest and RBS
- US Retail & Commercial including Citizens Bank and Charter One
- Ulster Bank
- RBS Insurance, including Direct Line
- Global Banking & Markets, the wholesale business
- Global Transaction Services
Then there is the legacy portfolio.
It seems to me there are at least seven stand-alone businesses that you could create from this: RBS retail, corporate and investment banking including transaction services, a universal bank; Natwest UK retail; a wealth manager/high net worth bank based on Coutts; a US retail bank; Ulster bank; an insurer; and the legacy portfolio.
Surely the sum of the first six would be worth more than the current RBS? Mervyn has a point: such a split is more likely to unlock value than hanging onto 80% of RBS for another two or three years, especially given how things have gone in the last four years. A split would enhance competition in UK retail; and there is little logic to having the insurance and US retail businesses in the same group. Coutts probably does have lower costs as a result of leveraging off the infrastructure of the rest of the group, so perhaps you could leave that with NatWest – similarly you might want to keep Ulster bank in that group. But whether it is seven, six or five businesses, the case for splitting up RBS is hard to argue with.
Update. RBS has just announced the sale of 229m shares in Direct Line Group (DLG), with a further over-allotment option of 22.9m. This would reduce RBS’ stake from 65% to 48-50%.
*I’m ignore the Markets and International Banking reorganisation.
Quick links March 7, 2013 at
I’m a little busy, so this will be short form:
- Jon Danielsson has a piece on VoxEU about the desirability of diversity in capital models. I don’t agree – I think we need fewer models used for capital purposes – but the argument is interesting.
- There’s a (sadly firewalled) opinion piece by De Larosière on centralbanking.com about the tradeoff between bank regulation and economic growth. Unsurprising, he comes down on the side of too much regulation (in places) and too little growth.
- LSE/LCH looks to be nearly done.
- Scott O’Malia is not happy about the CFTC approving CME’s trade repository.
- There is an effort to repeal the swaps pushout provision (section 716) of Dodd Frank. It is early days, but this may come to something.
- And finally… the corporate CVA exemption is apparently still in the near-final text of CRD IV. if you know what that somewhat opaque sentence means, then you will likely cheer: if you don’t, err, sorry, try here.
I will try to get to the RBS breakup news tomorrow.
Matt Stoller has a fascinating article on Naked Capitalism, Why Ron Paul Challenges Liberals. Paul is a complex character, distasteful in many ways, but not without interest. As Stoller says
when considering questions about Ron Paul, you have to ask yourself whether you prefer a libertarian who will tell you upfront about his opposition to civil rights statutes, or authoritarian Democratic leaders who will … aggressively enforce a racist war on drugs and shield multi-trillion dollar transactions from public scrutiny… Ron Paul’s stance should be seen as a challenge to better create a coherent structural critique of the American political order. It’s quite obvious that there isn’t one coming from the left, otherwise the figure challenging the war on drugs and American empire wouldn’t be in the Republican primary as the libertarian candidate.
In other words, Stoller uses some of Paul’s policies as a tool to shame the US left; why don’t they have an alternative account of the role of US military power, for instance? Even if (like me) you don’t agree with all of Stoller’s position, he does make a good point there. Part of the problem of course is that the modern Democratic party is in no way a party of the left; arguably one wouldn’t expect such a critique to come from a centre right party, which is what they are under Obama.
It is the paucity of two party politics, then, that really comes out of this example. There’s no need for the Dems to be a party of the left; they just need to be left of the Republicans, and there is plenty of room there. The barrier to entry for new parties is so high that the Democrats are unlikely to face competition from the left: even the Greens, with long-established support, are not a serious challenge. This allows both Democratic and Republican parties to be corporatist and finance-friendly. It’s only the occasional maverick, like Paul, who evidences the narrow range of positions taken in American politics.
I’m a little late with this, but it is interesting. Bart Chilton, CFTC Commissioner, on the futurisation of the swaps market:
while I’m interested in hearing the concerns about futurization, I am more concerned about, a silent creeper. That is, the “swapification” of the futures markets. Specifically, I’m concerned that the conversion of certain standardized cleared swaps will be under-regulated–under-regulated–in the futures markets. It may be block rules or something else, but we need to be cautious about converting certain swaps to futures in an attempt to export the deregulated, opaque swaps trading model to these new futures markets. Let’s be cautious about allowing lax oversight of these futures contracts, regardless of how they were treated before they were futurized.
The NYT gives us very good news on compensation in that most unlikely jurisdiction, Switzerland:
Swiss citizens voted Sunday to impose some of the world’s most severe restrictions on executive compensation, ignoring a warning from the business lobby that such curbs would undermine the country’s investor-friendly image.
The vote gives shareholders of companies listed in Switzerland a binding say on the overall pay packages for executives and directors. Pension funds holding shares in a company would be obligated to take part in votes on compensation packages.
In addition, companies would no longer be allowed to give bonuses to executives joining or leaving the business, or to executives when their company was taken over.
Of course you can bet that right now there are smart people devising A/B share structures where the votes go to the (tightly held) As and the divys to the Bs to get around this, but still, it is a strong and helpful signal.
Matt Levine is sad:
Today is a dark day.
His grief is for PAF2, an innovative regulatory arbitrage ahem I mean risk transfer deal whereby CS had their bonus pool write protection on a mezz tranche of derivatives receivables to get CVA capital relief. Or not. This deal probably wouldn’t have worked in most jurisdictions, and even in Switzerland it seems that its days are numbered. As IFRE tells us:
Credit Suisse may be forced to scrap or, at the very least, radically restructure [the deal]
The problem is that CS had to get protection on the senior to get relief, and no one really wanted to write that for what CS wanted to pay, so CS had to reduce the liquidity risk of the senior CDS by agreeing that if there was ever a payment on the senior, they would lend the counterparty the money to make it. So if the world goes to hell and CS lose a lot of money on counterparty credit risk – really* a lot of money – then they make a claim on the senior CDS which CS’s counterparty pays with money they have just borrowed from CS**. Um. Is that risk transfer?
As Matt says, Basel says no. Hence the problem.
Now, unlike Matt, I’m not sad, because this deal should never have worked. Regulatory arb that finds a clever way to transfer risk at the right price in order to exploit mis-designed rules is fair enough; reg arb that purports to transfer risk but doesn’t seems to me to be basically an arb not of the rules but of the regulator’s understanding of the trade. Unless, that is, they understood it but didn’t see the problem, in which case we have a bigger issue.
*Matt seems convinced that the senior attachment point was so high there was practically zero risk in the senior; I haven’t seen the trade details so I don’t know, but I will say that wrong way and concentrated sovereign risks can be significant in derivatives receivable securitisation structures, so one would want to be rather careful about the modelling before asserting something like that.
**And which, it appears, they can ‘pay back’ – in a very loose sense – by assigning the CDS back to CS.