Justice and markets
Gordon Brown told us on the Today programme this morning not to worry about the ill-effects of sickness in credit markets because βtransparency and regulationβ would see us right.
Which might have been an early-morning attempt at wry humour, but Iβm not so sure.
The Prime Minister's transparency and regulation are an aspiration, not a description.
The parts of the financial system which incubated the virus β the darkling, fetid jungles occupied by hedge funds and structured investment vehicles dealing in collateralised debt obligations and other complex products β are opaque and largely free from the kind of direct supervisory controls that constrain banks and financial institutions dealing directly with the public.
None of this would matter if the vast majority of us were unaffected by this malaise, if we could be detached bystanders. But the price of trillions of dollars of financial assets is determined in the darkling jungles and those assets are held by the banks on which we rely.
With a collapse in asset prices, there has been a generalised erosion of confidence in credit markets. That in turn has led to a steep rise in short-term interest rates, not the ones set by central banks but the ones that really matter, the that reflect the actual price at which commercial financial institutions are prepared to lend money.
Borrowing costs for businesses and consumers are rising.
Which is why central bankers have been pumping money into the global economy and will continue to do so β to try to ward off the evil of recession.
Those central bankers are in agonies of confusion, as evinced by the many weird and wonderful things theyβve been saying at their in Jackson Hole, Wyoming. They are torn between their duty to keep the global economy on track and their anathema for bailing out negligent investment bankers and hedgies responsible for this mess.
So quite an important question is whether those who behaved especially irresponsibly are paying a steep penalty. If the culprits are being punished, the global financial system would now self-correct. And there would be no need for Gordon Brown, other government heads, central banks and regulators to steamroller in and impose new restrictions on the free operation of markets.
Have the great investment banks, commercial banks and hedge funds learned their lesson? Can we be confident that they wonβt do it again?
Just asking the question makes me sound silly.
Yes, bonuses wonβt be so bulgy this year and quite a few financial rocket scientists β especially those specialising in radioactive collateralised debt obligations (CDOs) β have already been given the boot.
And yes, a couple of state-backed German banks, a few hedge funds, and some structured investment vehicles have suffered serious losses.
Also there are certain markets that have more or less evaporated (for now):
a) it is impossible to raise finance for a leveraged private-equity takeover, that boom has fizzled;
b) more-or-less all CDOs are being treated as toxic by investors, even those that might be palatable;
c) the enormous asset-backed commercial paper market is shrivelling to nothingness before our very eyes.
But letβs also not forget that the spoils of the boom that preceded this bust were on a mind-boggling scale and were largely pocketed by a few thousand hedge-fund owners and investment bankers. Many of those have cashed in tens of millions dollars each and are barely bruised by the recent turmoil.
For most participants in this market, the moral is pretty clear: they all got rich, and never mind the current mayhem. When a semblance of normal service is resumed, why not do it all over again, but perhaps with even greater gusto?
Whatβs more, where there is mayhem, there is opportunity. The smarties at Goldman, Morgan Stanley, Barclays Capital and the others are expected to coin it from clearing up the mess they in part created β through a business euphemistically called βrestructuringβ.
And they, plus the hedgies, have been raising lots of new capital to buy distressed financial assets, whose distress was caused by⦠yeah, you guessed it.
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It would be helpful to be less hysterical and more factual:
1. the asset backed CP market for certain mortgage securities has shrunk but NOT those for consumer finance (credit cards, car loans)
2. plenty of LBO will take place - just perhaps not the very largets ones, for a while
3. the rise in interest rates started in early 2006 - recent rises have added only a modest extra cost to the 1%+ since Easter 2006
4. please explain previous financial crises when the 'drakling jingles' didn't exist.
What solution do you propose to hold the people that profited from causing this mess in the first place?
This call for justice (criminal charges perhaps) could cause even more problems than could be prevented in the future.
Long have I argued ΒιΆΉΙη was a waste of money and had no spine/back bone.
It never has any point of view just because it wants to be seen as neutral.
By the time Evan Davis explains the concepts of the market its too late.
Even the barman down the pub knows more detail what he tries to explain.
For the first time, I'm reading someone who has the guts to rise up and tell it as it is. Even though he is talking against
1) the govt. of the time and
2) Big companies
Finally..
Thank God!
I know what I'd like to see happen and that's some of the institutions involved in this mess and who I'm sure will continue to fund PE companies, stick their mitts in their pockets and contribute to a high risk rolling seed fund of about Β£5m specifically dedicate to alternative energy tech projects.
Some colleagues and I have been trying to open discussions on such an idea and the reaction we're getting so far is extremely discouraging.
One of these days I just hope the institutions will understand that they have responsibilities and roles that go beyond what they'd like to think they are. If not then their reputations will just continue to go downhill..
Yes this is a major mess but in a "free" market perhaps the guilty parties are the instituitions who were willing to take the toxic waste etc. onto their books. Maybe in due course the shareholders of those companies will seek redress of the executive officers foolish enough to be taken in.
Some time ago I read a post that rasied the question of Mr Pestons like of business; I thought it quite churlish and inappropriate. Reading this blog has forced me to consider my then, snap, judgement. No one is forced to buy "toxic" products, and the CDO market is strictly for professionals. What bankers do in private is up to them, their boards and the regulators. And no, I do not work in the markets, I am an academic who would welcome fewer adjectives and more facts.
I would have thought that emergency reserve bank lending at punitive interest rates is the key to maintaining liquidity while ensuring that the cost is borne largely by the "guilty" parties. Is this too simplistic an analysis?
Robert, I applaud your clear analysis on the issues of the day, but I worry that perhaps you are fantasising of a "Judge Dredd" role for yourself in the City. Please do stick to reporting the facts in layman's terms, that's what we dutifuly pay our license fee for.
An excellent assesment of the situation,what message are the central banks sending out to those responsible? Speculate, and lend money to others to speculate, and you could make millions. Dont worry, if it all goes wrong Goverments will come along and bail you out. So you cannot lose, and even if you do I am sure your personal bank accounts are well protected.
One recurring theme in all the various aspects of the current problems is that when you pay people for initially making sales or deals but which they have no finanical interest in over the long term, you strongly incentivise them not to look particularly hard at the actual underlying foundations but just to make things sound good until they get paid. (And there are claims of some deliberately sweeping inconvenient details under the carpet, particularly in US subprime lending.)
I don't object to people in the financial industries making money when they're asked to use their financial expertise creating vehicles to connect borrowers and lenders, but when the attitude seems to be "we'll grab our commission money making deals and screw letting either side know the actual reality of this agreement defaulting, and maybe even make more commision restructuring it" then it does raise the question that if they lack professional ethics that much, why should, eg, my high-street deposit bank or pension fund do any business with them?
3 things have largely caused this mess:
1. Regulation applied carelessly - namely giving an effective (non-Nash) duopoly to S&P & Moodys to determine bond ratings for the purpose of institutional investors like Pension Funds and Mutual Funds to decide if they would buy certain debt instruments. A peer system would have prevented everyone taking their ratings on such "toxic waste" as gospel - people need to learn to not trust one point of authority - it often leads to disaster.
2. The second part of the mess stems from how banks, funds and other institutions are allowed to represent instruments on their balance sheets. Marked-to-model should not be allowed. Only when a portion of the trade has been active in the market should a fund be permitted to mark this as "worth" a certain value.
3. The third reveals a lack of foresight (knowledge) from the Central Bank, Hedge Fund and Investment Bank risk departments. Where were the Contagion Models and the Sensitivity Analyses? Where was the understanding that a blow up in certain CDOs would have immediate knock-on effects to the rest of the market?
I have been shocked to see how few senior bankers knew anything about Credit Derivatives.
Even now, there are no synthetic CDO contagion models which would show the effect on CDS spreads following an unwinding.
Even more worryingly, there are CDO^n instruments- a CDO^2 (CDO squared) is a CDO backed by another CDO.
A CDO^3 is a CDO^2 backed by another CDO. Thus a CDO^n is a CDO^(n-1) backed by another CDO!
Who can map and model this?
We need some sort of VisualDerivatives.com to see this.
Unfortunately, the Bond Market Association closed down www.CDOLibrary.com in April 2007. The very thing that could give us some inkling of the depths of this abyss no longer exists.
The mind boggles.
(I have been re-iterating this very danger for over 3yrs. Every investment bank and hedge fund I spoke to ignored the warnings.)
There is an underlying reality which investors forget and financial markets choose to ignore; there is only so much real 'profit' to go around! The more intermediaries that take a commission and the more the cake is sliced, the less everyone receives for their investment.
The economic dangers come with leverage - effectively increasing money supply. We all know that increasing the money supply devalues real money, but with world markets interconnected its possible that ALL currencies can devalue simultaneously, i.e. commodities and energy prices rocket. Like now!
The answer? Limit leverage. Insist that EVERYTHING requires a 20% cash deposit; house, car, shares, buying a company. Let's get back to sound economics.
And I thought _I_ had a chip on my shoulder....
There aren't enough smart people to go around. Some of the less-smart people become second-tier managers in companies like British Leyland or Enron. Some of them become second-tier hedge fund managers. Some of them even become journalists.
When the sun shines, the underachievers bask. There go wherever there is success at the moment - telecoms companies in 1999, energy trading in 2001, hedge funds in 2003. Then, when the wind blows they catch cold and the world goes back to its natural state - making money only where there is real value.
It's not the rich, smart cookies who cause the crashes. It's the idiots who _think_ they're rich, smart cookies.
Short of putting all these people into an Ark and shooting them into space, we're stuck with it. And Douglas Adam's eloquently pointed out the risks of doing that....
The jury is still out on this one... It will all become clearer by early october when banks will have to reveal just how ugly or not the sub-prime fiasco really is.
As for the people involved in this, they will probably not learn their lesson. Some people will lose their jobs, but probably the worst culprits will have cashed in their gains and start the hunt for the new financial Eldorado. However the average joe investor stung by this, will be licking his wounds until things change for the better. Probably not that much justice in this fact... However, at the risk of soundin as the devils attorney, investors got drawn in by the promise of substantial returns, which turned out to be empty promises, so the good ol "caveat emptor" should be at the forefront of investors thinking.
Robert, I am not sure, if politicians can do anything about it (bed credit fiasco) except making it more bureaucratic but people sitting other side of boundary ( Investment bankers, hedge fund managers and Private equity funds managers) are not the best bet either :(
One very good thing seems to have come out of all of this mess is that a degree of sanity has come into the market.
The stock market has boomed like a bubble based upon the thought that any company, however big, is a potential target for private equity. Boots is a classic case in point.
People have borrowed large sums on the basis of making short term gains by re-engineering the business.
They cut out anything they can that does not directly drive forward profits, take some money out then look to make some more money by selling it back on to the stock exchange or to some one else.
With the current tax regime for private equity the market is still skewed in the favour of high leveraged private equity and hedge funds. By allowing this to continue governments have caused all the current crisis.
We have had ten years of a government more interested in spin and tomorrow's Daily Mail headline not the long term benefit of the country.
Our pensions have been decimated by a short term grab and our childrens education, health and the long term finances of the contry are about to be destroyed by PFI and PPP over the next twenty five years.
Metronet may just be the first disaster but there are many more disasters waiting to come out of the woodwork.
After all what can we expect from a government that sells the UK tax offices to an offshore fund based in a tax haven.
In the immortal words of Billy Connolly it is too late to worry about the big things in life because the f***wits are in charge.
It has always been the case that the majority of people working at senior levels in the finance markets are primarily motivated by greed.
Expecting them to concern themselves with 'the greater good' is a foolish chimera.
Developments over the last decade or so have simply put more power in their hands.
Against this background the ultimate blame has to rest with those governments (particularly the UK's), who should have put constraints in place but instead have been content to turn a blind eye and accept the donations.
PS: You being hysterical? No, I think it's about time someone rattled the bars on the cages.
As Jonesy used to say, don't panic! These are only paper losses. Money is just an idea. My advice for everyone is not to take it too seriously. Have a lie in bed, watch daytime TV, have a smoke and make some home brew. Whatever you do, don't worry - leave that to the suits, who are paid for it. Lastly, be like my uncle Jack. He never made much money after the war, but he turns 100 this month and he's still smiling because he's outlived his debt collectors!
Not wanting to be "euphemistically restructured" myself, I have long advocated the more continental practice of central bank revision. That simply involves no more than two central bank inspectors arriving on-site (international branches included) and applying a handful of tests. It may result in a plethora of requirements, especially for banks with a "culture of negligence", yet for the longer term benefits of the really serious players has proven invaluable whilst remaining the only viable way to avoid paying lip service vis. Gordon's "transparency and regulation".