A Cypriot Tragedy

Tragedies are usually associated with Greece - a tribute to the richness of its theatre in the 5th Century BC. Over the weekend, you could be forgiven if you changed your tastes to a Cypriot tragedy. For that's exactly what has happened - albeit in the more prosaic world of economics.

 

These are the facts. Cyprus is another Eurozone country in deep trouble. It needed a bailout. So far, nothing unusual. A bailout was duly announced over the weekend. It was the terms of the bailout that sent a jolt reverberating through the world of economics. The EU is bailing them by about €13 bn (chickenfeed by the standards of bailout). But the conditions of the bailout are that all bank depositors would be levied a tax of between 6.75% and 9.9%. That means on Tuesday when banks opened, all depositors would lose that amount instantaneously.

 

The genesis of the problem is, alas, not new. Cyprus is a very small country. In boom times, it went berserk pushing its financial industry, positioning itself as an island finance centre. That's fine, but it just went way over the top. Cypriot banks had made loans to outsiders equivalent to 8 times the country's GDP. Worse still, a lot of those was to Greece its neighbor. When Greece began to go under, Cyprus was given an almighty whack. The bailout was then a question of when, and not if.

 

Another actor muddling the issue is Russia.  Of the € 68 bn bank deposits which are going to get a "haircut" (the tax referred to above) , a full € 21 bn comes from Russian companies. We shall not speculate where from this close affinity of Russia came from - let us just say that the word "money laundering" comes to mind. Now the Russians will instantly lose € 2bn. Enter Vladmir Putin. He is howling against the "$%^&* Germans who are the orchestrators of the bailout.

 

What about Joe Public in Nicosia. Even if you had say € 100 Euros in the bank, tomorrow it is only € 93. If ever there was a recipe for street riots, this is it.

 

And what about nervous bank depositors in other troubled countries - say Spain or Italy. Tomorrow it might be their turn. Only an idiot will keep his money in a bank anymore if you are an European. Take it out IMMEDIATELY. Dig a hole and bury it in your backyard. Keep it under the pillow. But don't deposit it in a bank even if a gun was pointed at your head.

 

What a mess. The world badly needs a new economic order. Fire all economists. Go back to the basics of countries balancing their budgets. Living within their means. Curbing the excesses in the banking and finance industry ruthlessly. It will be a prolonged period of pain. But when the clouds disperse, it will be a saner and fresher world. 

 

This, of course, is a Utopian dream - which leader is going to tell the truth to his voters. And even if he did, which voter is going to accept it. We shall stumble along from one crisis to another.

Bye Bye New York Stock Exchange

OK - the title is pure hyperbole. The New York Stock Exchange (NYSE) is going nowhere. But the company that owns NYSE is just being bought over. The curious part of the story is that the acquirer does not really want the NYSE, but it comes as part of the package- so he has to take it !

Here's the deal. NYSE is part of a conglomerate called NYSE Euronext. The conglomerate consists of NYSE itself, Euronext, which is a combination of three European stock exchanges and Liffe which is a London based derivatives exchange. NYSE and Euronext are ugly spinsters nobody wants. The beauty amongst the beasts is Liffe. For it is the sexy new hottie - a derivatives exchange.

And therein lies the story. In the modern day casino , that is finance , equity exchanges like NYSE are worthless as businesses. Margins are supposedly low. Stock exchanges are the places where almost all companies that require capital list and that's where investors channel their savings into productive investment. One would have thought that  the raison d'être for financial markets was to fulfill that objective, but obviously I am an old foggie.

In today's world, the money is all in running commodities exchanges,  derivatives markets etc - not boring old equity. The acquirer is a company called ICE that did not exist before 2000 (for the record NYSE was founded in 1817). ICE purely handles derivatives trading. The career of Jeffrey Sprecher, the CEO of ICE says it all. He started his career building power plants.  But he realised that there was more money (in facts tons more money) playing on financial contracts relating to power than in generating power itself. So he started ICE , obscurely in Atlanta, in 2000. See where he has got to in 12 years.

We've now come to a stage where even the NYSE is an unattractive prize - in fact positively repellant. Given a choice Mr Sprecher would probably spin off NYSE, or sell it off somewhere or simply forget about it. Unfortunately that is politically simply unthinkable. So he has to live with it and make pious noises of how important it is.

Its a symptom of where the world is going.  This post is one sided and biased (whoever said that a blog has to be objective !). Derivatives markets are not all evil and equity markets are not all saints. Both serve useful economic purposes. But you can see where this is headed. Esoteric, ununderstandable financial structures are getting to be more important than the underlying asset itself. That's why, a wise old fox from Omaha, back then in 2003, called derivatives a weapon of mass destruction.

Many years ago, when the world was a simpler place and when this blogger was a young man (!), he went to 11 Wall Street, entered the visitors gallery of NYSE and gazed at the trading floor in awe.  Little did he know that not in the too distant future, this lovely lady was going to be thrown out into the street as an ugly old crone.

Oh ! What a mess

Come on Argentina. How often do you ask everybody to cry for you ?  On Wednesday, a US District Court Judge detonated an atom bomb (metaphorically, thankfully), in the world of financial markets. As usual, Argentina was at the centre of it. Here is the story, with a little bit of history.

In 2001, Argentina defaulted on its sovereign debt - one of the rare instances of a major country doing so. A default essentially means that a country has no money on the due date to repay a loan it had taken and tells the creditors to fly a kite. The consequences of such an action are drastic - the country immediately becomes an international pariah in financial markets and nobody would lend to it anymore. That has been Argentina's lot for the last decade, and the situation Greece is desperately trying to avoid today.

When Argentina defaulted, most of its creditors got together and negotiated a "restructuring package" which meant that they would get something back at least - spread over a long period of time. It was a crappy deal for the creditors, but at least they would get something. They did this settlement twice- once in 2005 and again in 2010.

Two hedge funds Elliott Associates and Aurelius Capital, however chose not to negotiate and filed a case in the US courts asking for payment in full. The court gave its sentence last Wednesday, which is the metaphorical atom bomb I referred to. The judge ruled that Argentina will have to pay in full to these two hedge funds who sued, even in priority to the vast majority of creditors who settled ! The amount is some $1.3 bn.

This action is like poking a stick in a hornet's nest. All sorts of ramifications abound. First is the predictable response from Argentina, telling the US judge to go stuff himself, saying he cannot order a sovereign nation to do anything. But since the original debt was issued in the US and in dollars, there is some jurisdiction for US courts. However, short of sending in the army, how would the US enforce this decision ? It is hardly likely to start a war to satisfy two hedge funds.  It can resort to freezing Argentinian assets and the like, creating a messy situation.

The creditors who negotiated and settled are crying foul. They will have to wait for some 30 years and get a percentage of the amount, whereas these two funds are supposed to get their money in full immediately. They are suing to stay the decision giving these two funds priority. So anybody who negotiates in future is an idiot. Greece, which is trying to negotiate a restructuring package currently is quivering in the boots.

Then there is the question of a nation "starving" to raise money to pay "evil hedge funds". An angle that is sure to stoke the fires against wicked capitalists. Cristina Fernandez, the Argentinian President, who can effectively rabble rouse, is already singing this tune.

Argentina is appealing (interestingly while saying that the US courts should f@&* off at the same time !) . This will go all the way to the US Supreme Court. 

All this raises the issue of countries borrowing too much and not being in a position to pay the debt back. Very often the money borrowed is wasted away - in subsidies, doles, etc etc. Every country is guilty of this; just witness what the US is up to with debt at completely unsustainable levels - where are they spending the money they are borrowing ? - in fighting wars in Iraq and Afghanistan, in providing free health care to the elderly and the poor and doling out money to the unemployed. How will any of this yield a return so that the debt can be paid back ? Every country is simply borrowing more to pay back the original debt and keep doing exactly what it has been doing.

 Oh ! What a mess.

Even crooks deserve a fair deal

Remember Jérôme Kerviel  ?  OK, very excusable if you have forgotten who he is. He was the rogue trader who almost brought Société Générale ( a reputed French bank) to its knees. This happened in 2008. Kerviel was a trader who punted like crazy in the casino, that is euphemistically called financial markets - he was making gigantic bets that involved European stock index futures. The whole thing unraveled, he was fired, Société Générale tottered and ultimately lost € 4.9 bn.

 

Criminal proceedings were launched against Jérôme Kerviel  and he was sentenced to prison and a fine. He appealed, and, on Friday, lost his appeal. What caught me was the quantum of the fine. He was fined € 4.9 bn, the quantum of the loss that Société Générale incurred.  A fine of € 4.9 bn ???? Kerviel has no money and is unemployed and probably unemployable. How on earth is he expected to pay  € 4.9 bn ?

 

This is outright crazy. The judges have fallen hook line and sinker to Société Générale's assertions that it didn't know what was happening and that Kerviel acted alone. PPPPlease ........ That, to put it mildly, is nonsense.  His bosses must have been cheering loudly as long as he made profits and have thrown the book at him, when the whole thing collapsed.  The bank didn't know ??????? Baloney.

 

Société Générale , and the judge, argue that the massive fine is to prevent him from capitalizing on his story by writing a book (which he has done) or making a movie. That is extreme logic. Every crook tries to make money from his infamy. Jeffrey Archer wrote a whole book about his prison experience and sold God knows how many copies. The fault is not that of the crook - the fault is with those who buy the book or go see the movie. 

 

Kerviel is not your ordinary villain. Sure he broke company rules and did unauthorized trading. But then a few thousand bankers have done the same . He made no money personally - even his bonus wasn't obscene. He was a case of gambling instincts gone completely out of control. Does he deserve a € 4.9 bn fine ?

 

The logic that employees are personally responsible to make good the losses that arise if they violate the rules is a dangerous one. Sometimes company rules are not explicit. Sometimes bosses nod and wink when they expect employees to do things that are shall we say, fifty shades of grey ! If I were to calculate the possibility of personal liability, when taking a business decision, I would never make a decision in the first place. Something like this is what is happening in Indian government circles today - no babu is making any decision for fear that Kejriwal will allege that he is corrupt. Everything has ground to a complete halt.

 

It is a reflection of the anger against bankers that public opinion has no sympathy for Kerviel. Nobody, but a few busybodies have raised a whimper. I however think this is an outrageous court decision. Kerviel deserves to be punished. He deserves to go to jail. But he should not be fined € 4.9 bn.

 

It is a mark of civilized society that even crooks are given a fair deal.

Oh no; Not again

This blogger is rather vain about his English. And yet he was completely flummoxed when he spotted the headline "JP Morgan loses $2bn in egregious error" . He has to sheepishly admit that he did not know the meaning of the word "egregious" and had to look it up in a dictionary :( Trust a banker to come up with an unintelligible world - at least unintelligible to one "master" of English :). It sums up the problem neatly. The financial world has gone so bonkers in dreaming up structures of incredible and ununderstandable complexity that we cannot sit by and watch this go on anymore.

JP Morgan is a well respected bank. Its governance is top class. It should be one of the models of all that is good about the financial sector. In  Jamie Dimon, it has one of the finest Chief Executives in the world. It has superb risk management systems, strengthened even more in the wake of the financial crisis of 3 years ago. And what happens - it manages to lose $2bn in  one quarter on credit derivatives trading. An "egregious error".

This casino has gone gone berserk and has to stop. Enough is enough. Here is this blogger's remedy which is an extreme extension of the Volcker Rule.

• Commercial banking must be made a boring business. No proprietary trading. List of what they can do is made boringly small and strictly regulated by a super Ramamritham. All bankers have to come to work wearing only a panchakacham (man) or madisar (woman) - the logic being that anybody dressed like this can't be a punter.

 

• Commercial banks continue to enjoy the implicit sovereign guarantee. They are not allowed to become too big. After a certain size, they have to break up into two; somewhat like an amoeba.

• This is a free world. So the downright crazy casino is allowed; but at only two places in the world - Las Vegas and Macau. If Europe makes too much noise, Monaco can also be let in.

• Any idiot who enters any of these three places is required to sign a pledge that he clearly understands that he is committing suicide. Before he starts punting, he has to get a license, which will only be granted after he spends one night in the ward meant for the dangerously criminally insane.

• No bail outs for the punters in these three cities. If they lose their shirt , or something worse, it is their funeral. The state may helpfully construct a 100 floor tower with a fast lift to the top so that those who want jump off are easily facilitated.

Period. No more discussions or engagement with the financial community.

PS : If you are still wondering what "egregious" means, Dictionary.com defines it as " extraordinary in some bad way; glaring; flagrant"

Without Comment

Brilliant article in the Financial Times today. Dripping with sarcasm and wit. Alas its a bit technical and you'll enjoy it immensely if you have a bit of background in finance, but even otherwise its a good read. 

For those not in touch with American politics or high finance -

John Corzine is a former head of Goldman Sachs. He was deposed by Henk Paulson.  Corzine then became a Senator from New Jersey and then Governor. He got defeated in the election in 2010, by Chris Christie who is the current Governor of New Jersey. After his defeat in the election, Corzine became Chairman of MF Global which has just declared Chapter 11 bankruptcy.

Oh no; Not again

Yet another rogue trader has emerged. This morning is ablaze with the news that UBS (a Swiss bank) could have lost some $2bn on account of the actions of one trader - Kweku Adoboli at its London office. Adoboli has been arrested last night and the details are only slowly emerging.  Nothing is proven as yet , but Adoboli might very well join his illustrious predecessors - Nick Leeson of Barings, Jerome Kerviel of Societe Generale, et al in the hall of Notoriety.

Apparently the losses stemmed from the trader placing bets, using the banks'own money on something called Delta One - trading in financial instruments linked to exchange traded funds. To lose $2bn, the trader must have been trading staggering sums of money. Clearly UBS has egg on its face. Quite apart from the massive loss, questions will be asked about risk management in the bank. How could they let such a big loss build up.

The question to be asked is what on earth banks are doing even indulging in such activities. They are cloaked under the respectable heading of "investment banking", but this is nothing other than pure gambling. Is this what banks should be doing - gambling in esoteric instruments that nobody else would even understand ? Banks think that they can build big risk management systems, but the truth is that traders are incredibly bright and frighteningly sharp and they will  find a way to beat the best of control systems. After all, traders often hold their managers and risk departments in utter contempt and consider it almost a rite of passage to hoodwink them.

The fig leaf that this is all somehow a very respectable activity couched in terminology such as risk management, investment diversification, hedging, providing liquidity and such other gobbledygook must be once and for all removed. Banks, if they wish to indulge in such activities, should label these departments as "Pure unadulterated gambling department", "Better than a Las Vegas casino department", "" The Wild Wild West",  "Punters Inc",   "Rogues' Lounge" , etc etc.

Plain English helps. Free drinks served by scantily clad waitresses roaming up and down the aisle is optional.

And bankers wonder why they are unloved by the public.

What was he thinking ?

You normally associate business leaders with high intellect, sound judgment, and in general, greater ability than many of us, mere mortals. Then I read this front page report in today's Guardian in the UK.

I had promised to myself that I'd stop writing about either bankers or Goldman Sachs after my last two posts on the subject. But what can you do when somebody makes a speech like that. And where does he chose to make these remarks ? In St Paul's cathedral, no less.

If you know of any greater act of appalling judgement, please let me know.

A Letter

Mr Lloyd C. Blankfein
Chairman and Chief Executive Officer
Goldman Sachs Group Inc.

Dear Mr Blankfein,

Congratulations on the stupendous third quarter results of Goldman Sachs, you announced yesterday. To achieve some of the best ever results in the firm’s long and distinguished history, just one year after its worst crisis, is a remarkable achievement indeed.

We are writing this letter to make a humble suggestion for your consideration.

As we all know, the financial crisis over the last two years has affected millions of people worldwide. We think you would agree that the financial services industry, and therefore Goldman Sachs, had some part to play in this. The United States government had to step in to provide assistance and guarantees to you last year to tide over the crisis.

I would suggest that some humility and just a hint of remorse, might serve the bank well. Arousing public anger, however fair or unfair the anger may be, is not in the bank’s best interests. We suggest that you consider donating the last quarter’s profit of $ 3bn, that the bank made, to a fund that can help those who lost their jobs in the recession or were directly affected. This will not make a significant financial impact on your bank, considering that its just one quarter’s profits. It can however make a significant impact on the lives of many people who have been devastated over the last two years. It would be an extremely graceful gesture of a large hearted organisation – its an opportunity for your bank to demonstrate that it has both those qualities. You may want to consider convincing your shareholders that such a move is their own long term interests.

It is unlikely that your bank will become the most loved organization as a result of the act, but it might prevent it from becoming the most hated.

With best regards

Bloggers Anonymous.

Something is not right with this world

Last year, virtually the entire financial sector in the world went belly up. 12 months on, Goldman Sachs reports a quarterly profit in excess of $3bn. Yes 3 BILLION DOLLARS. In one quarter. Profit

Goldmans is the one bank everybody loves to hate. But even by their standards, this is something. The last two quarters have seen the highest quarterly profits in their 140 year history.

Now, the economics I have been taught in college was that there is a positive correlation between risk and reward. If they have made such profits, they must have taken wild risks. Just a year after coming within an inch of annihilation, only a complete lunatic would take such risks so as to make this mind boggling profit.

Or else, the economics I was taught is wrong. In the post meltdown world, there is easy money to be taken. Without taking undue risks. So the reward for bringing the world so close to an abyss, is to be able to make unbelievable money by just being around and counting the cash; and the rest of the economy, including the taxpayer, be damned.

Oh yeah, they will say they are just so damned good that they have “earned” this money. Maybe, but still …They are not the only ones printing the money. Some others are too; JP Morgan made a tad more than even Goldmans.

Either way, something is not right in this world.

Can it be business as usual ?

Goldman Sachs, is reporting its quarterly results tomorrow (Tuesday). There is rampant speculation that they will report “blowout profits” – something in excess of $2 bn in the quarter. Remember, not so long ago, they received money from the government to stay afloat and they repaid it back recently. They were also a beneficiary of the bailout of AIG – they had significant dues from AIG which would have all been a write off, but for the government bailout of AIG and them paying their creditors like Goldman Sachs.

Along with the speculation on results, there is the inevitable speculation on bonuses. Analysts are falling over themselves in predicting the size of the Goldman bonus pool.

There is no doubt that Goldman Sachs made all this money by taking significant risks and managing them better. Everybody else on Wall Street envies them. Many hate them for their success.

In some ways Goldman Sachs are in no man’s land. If they report poor results, the markets will kill them (remember their shares have risen by 68% this year). If they report fantastic results, surely the government, the public and everybody else is going to wonder, how is it possible to make huge profits just months after virtual meltdown.

To me, this is a signal that “business as usual” has reappeared far too soon. After what all has happened, it just cannot be allowed to be so. Where Goldman Sachs goes, surely others will follow. There will be increasing clamour for everybody to lay their hands off and to let them carry on as before.

If Goldman Sachs does indeed report the expected “blowout results” its an urgent wake up call for governments around the world to focus on how this industry will be run – what regulation, what structures, what they will be allowed to do and what they will not be allowed to do.

One thing is certain. The world cannot afford to let them carry on “business as usual”.