Showing posts with label derivatives. Show all posts
Showing posts with label derivatives. Show all posts

24 July 2018

The Warning Part II: Financial Armageddon, Again - Blood Moon - Trump Trade Policy the Patsy?


"Ultimately, the same financial architecture that surrounded the housing mortgage crisis (almost certainly including 'naked' credit default swaps) has been replicated in the three key areas where debt is growing at a troubling rate: defaults in student loans, auto loans, and credit card debt...

Thus, as the tenth anniversary of the Lehman failure approaches, there is an understanding among many market regulators and swaps trading experts that large portions of the swaps market have moved from U.S. bank holding company swaps dealers to their newly deguaranteed foreign affiliates.  ['off balance sheet' part deux]

But, what has not moved abroad is the very real obligation of the lender of last resort to rescue these U.S. swaps dealer bank holding companies if they fail because of poorly regulated swaps in their deguaranteed foreign subsidiaries, i.e., the U.S. taxpayer.

While relief is unlikely to be forthcoming from either the Trump Administration or a Republican-controlled Congress, some other means will have to be found to avert another multitrillion dollar bank bailout and/or financial calamity caused by poorly regulated swaps on the books of big U.S. banks...

By their own design, large U.S. bank holding company swaps [derivatives] dealers and their representatives have crafted their own massive loopholes from Dodd-Frank swaps regulations, which they can exercise at their own will.

By arranging, negotiating and executing swaps in the U.S. with U.S. personnel and then ‘assigning’ them to their ‘foreign’ newly ‘deguaranteed’ subsidiaries, these swaps dealers have the best of both worlds: swaps execution in the U.S. under the parent bank holding companies’ direct control, but the ability to move the swaps abroad out from under Dodd-Frank.

As history has demonstrated all too well, unregulated swaps dealing almost always ultimately leads to extreme economic suffering and then too often to systemic breaks in the world economy, thereby putting U.S. taxpayers, who suffer all the economic distress that recessions bring, in the position of once again being the lender of last resort to these huge U.S. institutions.

The Obama CFTC tried to put an end to these loopholes through a proposed rule and interpretations in October 2016.  However, those efforts were never finalized
before Donald Trump assumed the Presidency.  There will almost certainly be no relief from these dysfunctions from the Trump Administration or Congress.

However, state attorneys general and various state financial regulators have the statutory legal tools to enjoin these loopholes and save the world’s economy and U.S. taxpayers from once again suffering a massive bailout burden and an economic Armageddon."

Michael Greenberger, Too Big to Fail U.S. Banks’ Regulatory Alchemy


"'We didn't truly know the dangers of the market, because it was a dark market,' says Brooksley Born, the head of an obscure federal regulatory agency -- the Commodity Futures Trading Commission [CFTC] -- who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country's key economic powerbrokers to take actions that could have helped avert the crisis. 'They were totally opposed to it,' Born says. 'That puzzled me. What was it that was in this market that had to be hidden?'...

'It'll happen again if we don't take the appropriate steps,' Born warns. 'There will be significant financial downturns and disasters attributed to this regulatory gap over and over until we learn from experience.'"

PBS Frontline, The Warning

While the mainstream media says 'Russia, Russia, Russia' and the Administration says 'Immigrants, Trade, and Deregulate' the Banks may be setting up the US taxpayer for another taste of Financial Armageddon and a multi-trillion dollar bailout under duress.

As Trumpolini says, the US Taxpayer is 'the piggy bank' that is going to be robbed.  But it may not be at the hands of foreign mercantilists, but by domestic predators, wrapping themselves in the Constitution and the flag.

Or perhaps Michael Greenberger and Brooksley Born are just alarmists that don't really understand modern finance.

But maybe, just maybe, the Fed and the regulators are conveniently asleep at the switch, again.  And we are going to be forced to go through that whole, horrible episode of hidden leverage and multi-tiered frauds for the great benefit of a very few and their enablers in the professions and the government again.

Do they really know?  Are the people charged with protecting the public sure?  Will we even care until its too late?  Is all this fear-mongering hoopla about external threats just another misdirection, a distraction from the real crisis unfolding?  Is Trump, and his trade policy, being set up as a patsy for the next crash?

I would say that the probabilities are unacceptably high that another black swan may be coming home to roost.  And that the beneficiaries of this rotten system will do nothing to stop it, again.


Related and h/t for link to this paper:  Wall Street’s Derivatives Nightmare: New York Times Does a Shallow [CYA] Dive




17 May 2017

SP 500 Futures - Gap Filled Intraday - The Gathering Storm


"Sometimes I wonder whether the world is being run by smart people who are putting us on, or by imbeciles who really mean it."

Mark Twain

The gap in the SP 500 futures continuous chart that we left behind a few weeks ago has just been filled intraday.

As a reminder this is a stock option expiration week, although as I recall May is not a particularly significant month.

I imagine a lot of enthusiastic call buyers have just been smoked out of their seats and their June positions.

The tension on the tape the last few days was palpable.  It just took some small event to trigger it giving its overlong duration and extent out of balance.

I don't think impeachment is on the table for President Trump, except in overheated Democratic rhetoric.   Although I would not rule anything out while The Donald has access to twitter.

The NDX has a quite a way to go to close its gap, but that is another matter. For my purposes the SP 500 futures are the bellwether.

I have pulled in my short positions, and just left some other risk off positions run, mostly in gold. No silver at this time for a trade.  It just doesn't work as well in a panic because of its precious/practical nature.

My cynical side says that this market pullback is just a long overdue correction in the Trump rally. But we will have to wait and see where the stock markets finds a footing, or if contagion of selling starts to trigger liquidations and some sort of selling feedback.

As I noted the other day, this is a concern for me because the nature of this rally has been narrow and price driven.  People were throwing money into passive index funds, which were rising steadily thanks to speculation in about ten stocks.

The 'big one' for the markets, as opposed to a major correction, will gain the most damaging momentum from the erosion in quality of private debt loads which are once again back to record levels, along with the extreme leverage in financial derivatives exposure held by just a few financial institutions.  That is the real nitro in this chemical mix.

If any financial breakdown spreads to the $222 trillion dollars in derivative exposure then it is time to hit the exits.   There is no way to bail out that sort of malfeasance gracefully without imploding the currency, theories about the ability to print money without limit notwithstanding.

Speaking of rotten fundamentals, the average growth in loans exceeds the average growth in hourly wages.  Thanks to Tony Sanders at Confounded Interest for that chart below.

Let's deregulate The Banks even more and hand out tax breaks to the one percent!  And spend all our time looking for Russians hiding in the shrubbery so we can blame them.

Sleep well.








12 August 2016

Pam Martens' Warning to the Fed and the Clintons in 1998 - And She Warns Them Again Now


It is the same players that we saw enabling reckless behaviour in 1998: Citigroup, the Fed, and the Clinton-led Wall Street Democrats.

And here we are again, almost eighteen years later, watching the same short term, selfish behaviour by the big money banks putting the entire economy of productive individuals at risk again.

"There’s something big and scary going on behind the scenes but, as usual, the public isn’t reading about it on the front pages of the newspapers...

Dodd-Frank was supposed to push the derivatives out of the commercial banks which hold the insured deposits to prevent another taxpayer bailout, the so-called “push out” rule. But in December of 2014, Citigroup was able to sneak legislation into the must-pass spending bill to keep the government running that overturned the push-out rule...

Using its insured bank’s balance sheet as ballast, Citigroup’s bank holding company now ranks as the largest holder of all derivatives in the U.S. According to the Comptroller of the Currency, the very bank that blew itself up in 2008 and received the largest taxpayer bailout in history, now holds $55 trillion in notional amount of derivatives.

But far more alarming is the type of derivatives Citigroup appears hell bent on gaining market share in trading. Last week we reported that Citigroup is plowing into credit default swaps, the very derivatives that blew up the big insurance company, AIG, in 2008 and forced a government bailout of AIG to the tune of $185 billion...

On March 8 of this year [2016], the Office of Financial Research, which was created under the Dodd-Frank legislation to monitor the buildup of systemic financial risks, released a study on Credit Default Swaps. Its findings were deeply troubling...”

You may read the entire article at Wall Street On Parade.






03 April 2013

CBC: Canada To Adopt the Cyprus Model of Depositor 'Bail-In' In Case of Bank Failure



The smugness of the Canadian politicians is reminiscent of the Bank of New Zealand. 

Perhaps that is what the political do when they are making plans for a gathering storm and they wish for everyone to remain on the beach in the meanwhile.

I could be wrong, but in my judgement nothing in the global banking system is safe if the massive derivative bubble collapses. 

It will not only take down the private banks, but quite a few sovereign countries as well.

I am of the opinion that in the States there will not be the same sort of 'bail in' but a 'print in' in which the Fed will supply as much money as is required, taking value from all who hold Dollars including foreign holders.  So in that sense, the US is 'safe.'  It is all the holders of dollars around the world who are not.

You may wish to take some protective measures if you have not done so already.   When the times comes, there will be no time.

Ottawa weighing plans for bank failures
By Neil MacDonald
April 3, 2013

Buried deep in last month's federal budget is an ambiguously worded section that has roiled parts of the financial world but has so far been largely ignored by the mainstream media.

It boils down to this: Ottawa is contemplating the possibility of a Canadian bank failure — and the same sort of pitiless prescription that was just imposed in Cyprus.

Meaning no bailout by taxpayers, but rather a "bail-in" that would force the bank's creditors to absorb the staggering losses that such an event would inevitably entail.

If that sounds sobering, it should. While officials in Ottawa are playing down the possibility of a raid on the bank accounts of ordinary Canadians, they chose not to include that guarantee in the budget language.

Canadians tend to believe their banks are safer and more backstopped than elsewhere in the world. The federal government enthusiastically promotes the notion, and loves to take credit for it.

It may well be true, even if Canada's six-bank oligopoly isn't terribly competitive, at least in comparison to the far more diverse American banking universe.

But in the ever-more insecure world that has unfolded since the financial meltdown of 2008, it is also increasingly clear that nothing is safe anymore, not even blue-chip bank stocks and bonds or even, in the case of the Cyprus bail-in, private bank accounts.

And now, Canada is making a bail-in official government policy, too...

Read the rest here.


04 October 2012

Financial Fukushima: US Big Bank Derivative Bets Double in Six Years To $236 Trillion


Well, the derivatives market is like Fukushima Daiichi before it failed and melted down, when the utility company and the Japanese government were blithely assuring themselves and everyone else that nothing could go wrong. Just as Greenspan and other very important people said nothing could go wrong with the US housing market and the wholesale collateralization of debt. Nothing to see here, move along.

I was working on my own update, between the usual distractions, of the Sept 2012 BIS information, when Peter Miller sent this nice summary of the situation my way. A relatively small number of very large banks represent enormous counterparty risk to the world financial system because of the almost geometric growth of the largely unregulated and historically unprecedented derivatives market.

The distortions caused by such massive leverage ripple through the financial system, with both intended and unintended consequences, including the distortion of real markets and the transfer to and concentration of wealth in the money manipulation sector. And the marriage that the financial sector has made with politics is particularly dangerous to the average person.

This affects every country through the transmission power of the US Dollar and its pre-eminent role in decision making in our financialized world economy.

OurBroker
Big Bank Derivative Bets Nearly Double In Six Years
By Peter G. Miller
October 4th, 2012

America’s major banks now hold derivatives with a notational worth of $225 trillion – about a third of the world total. No kidding. Trillion.

And that’s up from a mere $120 trillion six years ago. Rather than being weened off derivatives, America’s big banks are more deeply entrenched then ever.

Hopefully Wall Street has it figured out just right and there won’t be any major losses, say a few billion here or there. After all, when has Wall Street ever been wrong about financial instruments?

“Derivatives are dangerous,” says Warren Buffett. “They have dramatically increased the leverage and risks in our financial system. They have made it almost impossible for investors to understand and analyze our largest commercial banks and investment banks.”

While many in Washington would like to limit derivatives trading, make such trades open to public scrutiny or both, Wall Street is vehemently against regulation.

In fact, there’s a simple way to resolve derivative worries. Allow unlimited derivatives trading — but only by individuals and partnerships willing to personally take the risk of profits and losses...

According to the Bank for International Settlements (BIS), the notational value of derivatives at the end of 2011 was $648 trillion.

The gross credit exposure from these securities was believed to be $3.912 trillion according to the BIS — that’s up from $3.5 trillion at the end of 2009.

But what if the estimates are wrong? For instance, let’s say losses are just one tenth of one percent bigger than expected. Not a big deal, except in the context of international derivative levels that’s more than $640 billion.

Do taxpayers have exposure? You bet. According to the FDIC, at the end of June 2012 all depository institutions held derivatives with a notational value of $224,998 trillion. However, such bets are not spread across the entire banking system. Banks with at least $10 billion in assets hold virtually all derivatives, securities with a notational value of $224.803 trillion. While the FDIC insures deposits in some 7,200 banks and savings associations, only 59 FDIC-insured institutions have deposits of more than $10 billion. Your little community bank, savings association or credit union likely has no derivatives department.

Derivatives are simply bets. They finance no factories, no research, no colleges, no homes and no cars. Any jobs they produce are incidental and inconsequential relative to the potential risk they represent, the risk that credit exposure has been incorrectly figured by hundreds of billions of dollars if not more. Since big banks hold virtually all derivatives, and since taxpayers can face massive costs if big banks fail, it follows that something should be done to limit taxpayer risk....

Read the entire story with an explanation of derivatives here.

Here is a glossary of terms which you might wish to keep.

04 May 2012

ETFs Part 2: The Next MF Global or Trigger For a Broader Collapse - But Timing Is Everything



It is the introduction of synthetic derivatives in place of actual holdings, and the abuse of counterparty exposure with one's own organization thereby concentrating risk, that start to make these financial creatures look even more deadly, and more like control frauds, than one might have previously imagined.

I think that when one of these constructions fails, as one must almost surely do, we will then have either an MF Global moment, wherein one institution goes down and quite a few customers find that they are holding worthless paper instead of assets, or even worse, an enmeshed counterparty risk triggers another Lehman-like freeze in the credit markets and, as the dominos fall, a new financial crisis even worse than the last.

The nastier version would almost certainly occur if the failure and subsequent disclosure of fraud occurs in some commodity ETF. Why?

In that instance it is more difficult and much more noticeable, although not impossible, for the Congress and the Fed to throw loads public money, and subvert justice, to make the problem and full disclosure of fraud to go away.

Stocks and bonds are relatively easy to counterfeit; physical commodities take a little more energy, boldness, and imagination, the challenge of the shell game rather than the relatively mechanical process of inflating the world's reserve currency on behalf of financial friends with benefits.

So before you short stocks in your trading account, with abandon and quite possibly into insolvency, keep in mind that the Fed is perfectly capable of fomenting another bubble to save the status quo, as they did in 2002-2007. To underestimate the corruptibility of the Fed and the government in partnership with the banks and their corporations can be a costly lesson indeed.


ETFs – Part 2


So far so vanilla. Now lets look at how, as the ETF market has grown, the clever boys and girls of finance have found ‘innovative’ ways of pumping those ETFs up a bit, just like they did to Securities.
Use of Derivatives in ‘Synthetic’ ETFs

The main innovation in ETFs has been the creation of what are called ‘synthetic’ ETFs which instead of actually buying or even borrowing a basket of shares, use derivatives to track the value of the underlying market without the need to match its composition. Instead the Synthetic ETF enters into an asset swap agreement with a counterparty using an over-the-counter (OTC) Derivative. Before explaining what the heck that means let’s just look at how quickly the Synthetic market has grown.
Synthetic ETFs have grown very rapidly in Europe and in Asia. In Europe Synthetic ETFs are now 45% of the over all ETF market. Synthetics doubled their market share between 08 and 09.

The key to Synthetics is the Counterparty.

What happens is the ETF Sponsor designs the deal, the AP (Apporved Participant. Usually one of the big banks or brokers) buys the basket of assets to make it, but then swaps that basket with the Counterparty for a different basket of assets in a derivative swap deal. However it turns out that rather too often for comfort, not only will the Sponsor and the AP be the same bank, but more often than not it will be the Asset Management branch of the same bank who will be the Swap Counter-party as well. It is quite common for the same bank to play all three roles. So a single bank creates the ETF, appoints itself as AP so it can fund it and then its Asset Management desk becomes the derivative counterparty in order to mutate the whole thing into a synthetic ETF. Think about what this does to the risk. What was market risk, where the risk was spread out across all the different shares, is now a single counterparty risk. The bank has effectively put all the ETF’s risk in one basket – itself.

But even if it is a different bank acting as the derivative counterparty the situation is only very slightly less incestuous because it is nearly always the case that the Sponsor, AP and Counter-party will all be from the same small group of big banks, brokers and Asset Managers. And it is also a statistical fact that all of them will be counterparties with each other many, many times over, via the over $1.2 Quadrillion of other repo, rehypothecation and derivative deals. This, as the Financial Stability Board’s report on instabilities in the ETF market rather laconically puts it,

…may also generate new types of risks, linked to the complexity and relative opacity of the newest breed of ETFs. The impact of such innovations on market liquidity and on financial institutions servicing the management of the fund is not yet fully understood by market participants, especially during episodes of acute market stress.
Not fully understood? I think we may not have understood what such entanglements of reciprocal risk meant before the first period of ‘acute market stress’, but I think now it is nutty to imagine the banks don’t know how risky such risk incest really is. The FSB report itself concludes,
Since the swap counterparty is typically the bank also acting as ETF provider, investors may be exposed if the bank defaults. Therefore, problems at those banks that are most active in swap-based ETFs may constitute a powerful source of contagion and systemic risk.(P.4)
Please step forward Deutsche Bank and Soc Gen!

A “powerful source of contagion and systemic risk”. Sounds really good for you and me. So why are the banks doing it anyway? The official answer is that using Derivatives means the ETF can track the value of the market more closely. Though few have complained that Vanilla ETFs don’t track closely enough. And as the BIS report points out,
…the lower tracking error risk comes at the cost of increased counterparty risk to the swap provider. (P.8)
But this doesn’t answer why a bank would enter into a swap with itself as the counterparty. The whole idea of counterparties, once upon a time, was to hedge some of the risk in the original deal by passing it off to someone else. Using yourself as counterparty keeps the risk in-house. So once again why?
The answer is, according to the BIS report on ETFs,
…that this structure exploits synergies between banks’ collateral management practices and the funding of their warehoused securities. (P.5)
‘Synergies’ sounds like it should be good. Sadly it may not be. As the BIS goes on to explain,
…synergies arise from the market-making activities of investment banking, which usually require maintaining a large inventory of stocks and bonds …. When these stocks and bonds are less liquid, they will have to be funded either in the unsecured markets or in repo markets with deep haircuts. (P.8)
In essence it costs the banks money to have illiquid assets on their books. The repo markets won’t accept them as collateral unless they come with a deep haircut. So the banks can do little with them except sit on them. Basically it costs the bank to have the illiquid, hard to sell or Repo, stocks on its books. But.. .if they happen to have created a handy synthetic ETF, then everything changes because,
For example, there could be incentives to post illiquid securities as collateral assets [in the ETF Swap]…. By posting them as collateral assets to the ETF sponsor in a swap transaction, the investment bank division can effectively fund these assets at zero cost….
Handy isn’t it? Assets they can’t repo without hefty haircuts can be posted as collateral to their own ETF with the approval of the ETF Sponsor of course – who will just happen to be… the same bank – without those pesky, hurtful haircuts. In fact,
The cost savings accruing to the investment banking activities can be directly linked to the quality of the collateral assets transferred to the ETF sponsor.
The worse they are, the more illiquid, the more the bank saves/makes by choosing to put them in an ETF rather than having them loiter on its books.
…the synthetic ETF creation process may be driven by the possibility for the bank to raise funding against an illiquid portfolio that cannot otherwise be financed in the repo market. (FSB report P.4)
This is surely financial innovation at its shining best.

Now of course the banks will say they would never consider slipping some old tat into their ETF under cover of opacity. Except that they did, every one of them, do exactly that when they systematically and grossly lied about every single aspect of hundreds of billions worth of shabby mortgages which they intentionally stuffed into CDOs in order to shaft and rob those they sold them to. This is a matter of public record...."

Read the rest here.

See also Part 1 - ETFs and Derivatives Will Be the Trigger Event For the Next Financial Crisis



"The World Is Deaf" (ou peut-être, 'fou furieux à nouveau' - Jess)




03 May 2012

ETFs and Derivatives Will Be the Next Trigger Event for a Major Financial Crisis


ETFs and derivatives may be fine for a trade or a hedge to a trade, but by no means are most of them that I have looked at worthy of a long term hold.  I distinguish them by their opacity, leverage, and lack of transparent audits from legitimate physical trusts.

And some of the ETFs, especially in commodities and on the short equity side, appear to be almost fraudulent both in construction and representation, and are often more instruments of manipulation and raw speculation for extracting wealth from the less sophisticated than investment vehicles. 

The great story of this financial era is the same of all the control frauds that have preceded it: leverage founded on paper claims, asymmetrical information, and the calculated mispricing of risk.

And when the ETFs fail it will be an echo of the market failure of 1929 when firms like Goldman Sachs enjoyed spectacular growth, promoting investment trusts, that blossomed late in the paper speculation of the 1920's, and became a major source of kindling for the flames.  Enough so that John Kenneth Galbraith devoted a chapter to Goldman and the Trusts in The Great Crash of 1929.

"For a long the the New York Stock Exchange looked with suspicion on the investment trusts; only in 1929 was listing permitted. Even then the Committee on the Stock List required an investment trust to post with the Exchange the book and market value of the securities held at the time of listing and once a year thereafter to provide an inventory of its holdings...

It is difficult not to marvel at the imagination which was implicit in this gargantuan insanity. If there must be madness something may be said for having it on a heroic scale."

John Kenneth Galbraith, 'In Goldman Sachs We Trust,' The Great Crash of 1929

I do not know if we are done with bubbles. We might see another yet again. It almost seems likely given the reckless apathy of the public and the passionate resistance against reform fostered by the powerful few. 

And do not presume that these monied interests will shy away from their possible self-destruction in precipitating another financial crisis and collapse.  They are emboldened by their recent brushes with disaster in the manner of the moral and emotional sickness which they share with psychopaths.  They will not respond to reason, because their motivations are not rational, not based in reason.  Was Madoff rational?  I do not think so.  He was intensely deluded and self-destructive.

Even in the ashes of another Great Depression, the powerful see the opportunity to take command and overturn the democratic republic that so inflames their swollen pride and sparks their fears, that a government of the people, by the people, and for the people has endured despite their best efforts to subvert it for themselves.  As they so proudly imagine, they are not like 'us.'  The greed to keep their ill gotten gains, and the will to power to gain more control over others, their inferiors, knows no bounds.

ETFs – The Next Accident Waiting to Happen?
By Golem XIV
May 3, 2012

Where will the next point of instability be? Not what will trigger the next liquidity and credit crunch and cause the next landslide of panic selling and losses. We can already see many candidates for the trigger. But what will be the mechanism by which it is amplified and spread?

I think that in a couple of years, unless something alters the current trends in money flows, we will come to know ETFs the way we already know the securitization and packaging of sub-prime mortgages into CDOs. I think the signs are already there to suggest ETFs are where the instability and risk is accumulating. If I am in any way correct then ETFs will be to the next stage in our on-going state of siege-mentality crisis what CDOs were to the last...

Read the rest here.

27 March 2012

Warren Pollock: Overall Derivative Market Contracts - Warning Signs



I have spoken before about the fallacy of netting and the danger of instability in the derivatives market.

Critical Mass: The Mispricing of Derivatives Risk and How the Financial World Ends


Here is Warren Pollock's take on this and on the recent contraction in nominal value of the global derivatives market.

"Ponzi schemes can go on for a long time under the mask of expansion; these frauds blow up during a contraction of new money being input into them.

Such may be the story of credit derivatives as we see a working contraction in the notional value of these instruments as reported by the comptroller of the currency. In simple terms the number of these instruments has gone down to a mere 240 Trillion!

The premise for this ponzi is the concept of netting whereby risks off offset on paper under the false justification that positions can become risk neutral. In this ponzi scheme the efficacy of the netting process has magically risen from 50% or so to an astounding 92.2%.. This means that the reported risk of 240 Trillion is only 8% of the notional amount.

In less insane times the notional risk was reduced to a mere 50% through the netting process. Even with 8% risk not covered by netting the liabilities of JPM and others are far greater than their assets under management. The problem being that JPM's assets are secured by its liabilities and the liabilities of banks tend to be YOUR Savings.

With changes to Safe Harbor rules the government is not only facilitating fraud with these netting assumptions but they are also putting your savings at risk by giving the coverage of derivatives priority should there be a dispute. This very issue is being worked out presently with MF Global."



10 December 2011

The Big Question: Are Funds At US Financial Firms Safe?



The short answer is 'maybe.' It is more of a buyer beware situation than most had thought, and still think.

It is nice to see someone in the mainstream media addressing this situation intelligently and without making an apology for what is apparently a criminal act and surely an egregious abuse of the public trust.

It is an axiom that it is not the initial crime that does the greatest and most widespread damage, although in this case it appears likely that someone in MF Global is due for jail time.

The damage is going to be to the US and British financial systems, Wall Street and the City of London, and in a large part because of the capture of political process by the monied interests.

This week the Senate led by Richard Shelby turned down the appointment of Richard Cordray to head the Consumer Financial Protection Bureau.  They have vowed to block any appointee until they can change the law that authorized the Bureau in the wake of the financial crisis in order to provide 'accountability.'  For them that means the ability to control the Bureau and starve it of funds in order to protect their banking cronies on Wall Street.  

Nothing is ever perfectly safe in this world. But some things are safer than others and there are steps one can take to diversify their wealth and avoid higher risks.
'A wise person does at once, what a fool does at last. Both do the same thing; only at different times.' 

Lord Acton
If I am correct, there are even bigger scandals to come when the tide goes out again, although there will be great efforts made to cover them up and excuse them 'for the sake of public confidence in the system.'    The derivatives market is a scandal-in-process, and is likely to rock the US banking system and the Dollar to their foundations when it topples. 

There may be even larger losses and anxiety for the unsuspecting who have misplaced their trust in false ideologies, slogans and theories promoted by a self-serving oligarchy.

NYT
A Risk Once Unthinkable
By James B. Stewart
December 9, 2011

Are customer accounts at brokerage firms safe?

Until the collapse of MF Global, that’s a question I thought I’d never have to ask.

Brokerage firms are required by law to maintain segregated accounts holding all client assets, including stocks, bonds, mutual funds, money market funds and cash. The law was passed after the 1929 crash, in the depths of the Depression, to make sure that customer assets were there at all times, ready to be disbursed even if everyone asked for their money at once...

I had always assumed it was impossible and that strict internal controls existed at all brokerage firms so that firm officials couldn’t tap segregated customer funds even if they were willing to break the law.  Thanks to MF Global, it’s now apparent that isn’t necessarily true. “If people are determined to misuse customer funds, they will misuse them,” said Ananda Radhakrishnan, the director of the division of clearing and risk at the Commodities Futures Trading Commission.

That’s because the commodities and securities industry is mostly self-regulating, and self-regulation ultimately depends on the integrity of the regulated. Broker-dealers — securities firms that execute trades of stocks, bonds and other assets for customers — are overseen by the S.E.C., while futures commission merchants, which trade commodities, derivatives and futures, are regulated by the C.F.T.C. Like most large brokerage firms, MF Global was both a broker-dealer and a futures commission merchant, though its primary business was commodities futures trading...

Typically, this requires transfers from segregated accounts (other than at the customer’s request) to be approved by multiple officials, including in many cases, the firm’s chief financial officer and chief compliance officer.

It’s not a low-level functionary,” a regulator said. “It’s someone who has real standing. Most customer assets are held at the biggest firms and they have scores of people involved in this process....”

The law also allows commodities firms like MF Global to use segregated customer funds as a source of low-cost financing for their own operations, but they are required to replace any customer assets taken from segregated accounts with supposedly ultrasafe collateral of the same value, typically United States Treasuries, municipal obligations and obligations whose payments of principal and interest are guaranteed by the government.

This week, the C.F.T.C. issued new rules restricting how client assets can be invested, which had grown under C.F.T.C. interpretations to include sovereign debt and transactions known as “in-house repos,” or repurchase agreements, in which a firm contracts with itself to use customer assets as, in effect, interest-free loans to finance its inventory of Treasury bonds. MF Global was apparently a heavy user of in-house repos, and before his firm collapsed, Mr. Corzine had argued strenuously against the C.F.T.C.’s proposal to ban them.

Making bad bets on European sovereign debt — like making bad bets on United States mortgage-backed securities — isn’t a crime, but improperly transferring segregated customer assets is a potential criminal violation of the securities laws and a relatively straightforward one at that. (The United States attorney’s office in Manhattan is in the early stages of investigating the removal of customer assets from MF Global.)

I spoke this week to several people involved in the MF Global investigation. No one has reached any firm conclusions about how the assets were transferred, but possible innocent explanations have dwindled to almost none. And James B. Kobak Jr., a lawyer for the MF Global trustee, said in court on Friday that there were “suspicious” trades made from customer accounts. If that’s the case, there may have been a deliberate and concerted effort to override MF Global’s internal controls to gain access to segregated customer assets, and if that can be proved, those responsible should be prosecuted and, if convicted, go to jail.

Unfortunately for MF Global’s customers — and future victims of similar crimes, if that’s what it turns out to be — there’s no easy remedy and it will most likely be months or even years before they recover their money. The Securities and Investor Protection Corporation explicitly warns that it’s “not uncommon for delays to take place when the troubled brokerage firm or its principals were involved in fraud.”

SIPC will replace up to $500,000 of securities and cash (but not futures contracts) missing from customer accounts at member firms. A measure of the magnitude of the problem is that since its creation in 1970, SIPC has advanced $1.6 billion to make possible the recovery of $109.3 billion in assets for an estimated 739,000 investors (through the end of 2010).

Meanwhile, the C.F.T.C.’s enforcement capabilities, like the S.E.C.’s, have been starved for lack of funding...

Read the entire article here.

01 September 2011

Greenberger: Secret Exemptions Allow Futures Price Manipulation - RealNews



Michael Greenberger is one of my lights into these types of issues. He is a nice remedy to the mistaken theories of many, including alas Paul Krugman, who does not believe that speculators can influence prices, even in the short term. But there are far, far worse, who know better but sell themselves for pay.

Greenberger highlights the speculative pools activity of Goldman Sachs and Morgan Stanley. But there are far worse excesses being done by other actors through their own trading desks, among these JPM and HSBC it appears at least from government records, in the derivatives markets.

Anyone who watches the markets closely knows full well how derivatives and leverage can be used to manipulate the physical markets with paper in a fiat regime, especially where the "delivery" of goods can be financialized, leveraged, and nakedly shorted, behind the cover of opaqueness and complexity.

Thus the use of such financial tools allows some participants to essentially defer the equilibrium of supply and demand for unusually long periods of time, until some event or accident triggers an exposure, a sudden reckoning, and a subsequent collapse.

I think the extreme fractional reserve nature of the current metals markets is an accident waiting to happen, awaiting only the right mix of margin calls and short term demand. And then everyone will be surprised that such a grand theft went on for so many years, unnoticed, except that is by a stalwart few, much in the manner of the Madoff fund and Harry Markopolos.

The remedy for much that is wrong in the markets today can be remedied by transparency and limitations on things like positions, and a return to laws passed after the last financial crisis of this magnitude that had served the nation well for over sixty years.

More at The Real News

29 April 2010

Release the Kraken: Silver Market Price Rebounds After Sharp Price Drop for Options Expiration


"Corruption is a tree, whose branches are
of an immeasurable length: they spread
Everywhere; and the dew that drops from thence
Hath infected some chairs and stools of authority."

Beaumont and Fletcher, The Honest Man's Fortune

The silver market is rallying strongly today, after the recent dip in price below $18 with respect to the options expiration and delivery dates for the May contract earlier this week. When futures options are filled, one is not paid in cash, but instead they receive active futures contracts at the strike price.

The market game is to either get the front month price below the key strike prices before the expiry to make the options worthless, or to take the price down below the strikes the day after to run the stops of the contract holders. The market makers can see the relative levels of holdings in market in near real time, privileged information not permitted to the average investor.



Three or four banks are short more silver on the COMEX than can easily be attributed to legitimate forward sales or hedging for all the miners in the entire world, for years of production. Granted, it is hard to determine what the truth is because they are allowed to hide their actual positions and collateral, so as to be able to make their leverage and risk difficult to determine. It's the obsessive secrecy for improbable positions and returns that is the tell in most market manipulation and schemes such as Madoff's ponzi investments.

Goldman Sachs was able to obtain the exemptions of a hedger in the markets through contrivance, for the purpose of their proprietary speculation. But if Goldman is the vampire squid, then J. P. Morgan is the kraken of the derivatives markets, having less leverage than the squid as a percentage of assets, but significantly more reach and nominal size, positions which seem almost impossible to manage competently against value at risk in the event of a very modest market dislocation. And of course the risk which a miscalculation presents could shake a continent of counterparties. These oversized positions appear to be integral to the misprision of legitimate price discovery that is at the heart of derivatives frauds in other markets.

The 4Q '09 report from the Office of the Comptroller of the Currency reports that "The notional value of derivatives held by U.S. commercial banks increased $8.5 trillion in the fourth quarter, or 4.2%, to $212.8 trillion." J.P. Morgan alone has a total derivatives exposure that is larger than world GDP. Granted, by far most of these derivatives are based on interest rates, which are largely under the nominal control of Wall Street's creature, the Fed, at least for now.

Here is a description of the derivatives market by Carl Levin that seems appropriate to the current situation, but also to other market dislocations such as that of LTCM which foundered through the misapplication of risk management assumptions to enormously outsized positions.


"Ordinarily, the financial risk in a market, and hence the risk to the economy at large, is limited because the assets traded are finite. There are only so many houses, mortgages, shares of stock, bushels of corn, [bars of silver], or barrels of oil in which to invest.

But a synthetic instrument has no real assets. It is simply a bet on the performance of the assets it references. That means the number of synthetic instruments is limitless, and so is the risk they present to the economy...

Increasingly, synthetics became bets made by people who had no interest in the referenced assets. Synthetics became the chips in a giant casino, one that created no economic growth even when it thrived, and then helped throttle the economy when the casino collapsed."

These bets can be used to overwhelm the clearing price of physical bullion. Further, these bets distort markets, and those markets have an impact on the real commodity supplies and the economy, in the form of artificial oil and energy shortages for example as in the case of Enron. And given enough time these distortions can, through misallocation of resources, capital and labor, create real systemic shortages in key commodities that can take years to remedy, in addition to the short term damage and pain they inflict on countries whose economies rely on commodity exports.

Perhaps Senator Levin can reuse this quote when he questions CFTC Chairman Gary Gensler, another Goldman alumnus in government, and Sandy Weil's protege Jamie Dimon, when the Congress holds hearings on the defaults in the commodity markets and the requested bailouts of the banks who were holding enormously leveraged derivatives positions.

Unless, that is, the bailouts are conducted in secret, as Mr. Gordon Brown may have done for the bullion banks when he sold England's gold for a pittance. It is hard to know the facts of that sale because it has been hidden away by the Official Secrets Act. That type of bailout would be hard to do with silver, since the US has long since depleted its official holdings, and has trouble keeping its own mint in supply. But such a bailout might be done with the gold in Fort Knox and West Point, or the oil in the Strategic Reserve. And cash settlement is always an option, since the Fed does own a printing press.

I know this sounds a bit much at times, and there are plenty who will tell you to ignore it and move along. Tinfoil hat and all that. And it is natural to grow tired of it, to wish it would just go away. I know that I do.

But these things have happened, and continue to happen, and if you do not understand even now how the government and the banks are acting together in the the shadows for the benefit of the monied interests, you have not been following the news. Or perhaps you have, since the mainstream media largely ignores it, and investigates little or nothing, preferring the less expensive route of chairing phony debates between vested insiders, shameless promoters and paid position whores known as 'strategists.' The financial medai seems to have led the way on this, turning their 'news coverage' into an extended infomercial.

It is a dirty, shameful lapse in stewardship, and an overall failure in the upholding of oaths and responsibilities in public figures and officials. I have not seen anything like it since the Watergate trials which seemed to drag on interminably, and the scandalous behaviour and abuses that were exposed in the Nixon Administration. And it has only just begun to come out, but slowly. Because this time the US lacks a truly independent press that respects and investigates the evidence provided by whistle blowers, and is willing to question the sham explanations of the powerful insiders in the government and the financial sector.

And no one in power is recording anything for posterity, at least not voluntarily.

16 April 2010

SEC Formally Charges Goldman Sachs In Derivatives Fraud with Paulson and Company - another 'Rogue Trader at Work?'


“Only fraud and falsehood dread examination. Truth invites it.”
Dr. Samuel Johnson

The SEC is formally charging Goldman Sachs with fraud in the derivatives markets, specifically with regard to Collateralized Debt Obligations related to subprime mortgages.

Investors in Goldman's Abacus CDO lost one billion dollars.

In addition to the company, an individual VP in Goldman's international group is being charged, Fabrice Tourre.

Paulson and Company, a major hedge fund, paid Goldman to structure a CDO based on mortgages that Paulson selected, so that they could bet against it.

"The product was new and complex, but the deception and conflicts are old and simple. Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party,” said Robert Khuzami, director of the division of enforcement.
This could be construed as a deft way of throwing red meat to the angry mob, nailing a specific individual at Goldman while limiting the criminal charges against the company although there will be significant civil cases, and dealing with the billionaire hedge fund owner Paulson who made a fortune betting against the subprime market.

This could be more damaging if this includes other Goldman bets against its customers on products it represented and created, and it shows an overall intent to create fraudulent products for the purpose of shorting them. For now the SEC will not say if this fraud is a singular event or more systemic.

Goldman will almost certainly attempt to spin this as the actions of a 'rogue trader' who was an aggressive exception.

Last week the White House asked Jamie Dimon and Lloyd Blankfein to 'cool it' on their intense lobbying efforts against derivatives and financial reform.

Perhaps this will help them in their decision.

This is just the tip of the iceberg. The Wall Street Banks are knee deep in fraud.

No one can obtain the kind of consistently odds defying returns that Goldman was producing without either cooking the books or engaging in some type of gaming the system, which is a polite word for fraud. That is the same 'tell' as the steady and outsized returns that Madoff is producing.

Let's see if this goes any deeper, and if serious punishments and reforms result.

The SEC can only enforce the Securities Laws, but cannot bring criminal charges. Since Paulson is not being charged, since he made no representations regarding the products, only Goldman is being sued by the SEC. Their alleged gain in this is $15 million dollars, the fees it obtained from Goldman. And Goldman will say that they were only serving their customer, Paulson.

Certainly Goldman will be subject to civil lawsuits and discovery. But the real test of the Obama government will be any role that the Justice Department does or does not take in this. They could of course defer, using the show trials of the Financial Crisis Inquiry Commission as a rationale to take no action.

This is blatant fraud and white collar crime being conducted by an organization that is paying contributions to half the Congress and the Administration, and staffing key positions in the government with its employees. Do you really think it will be brought to full disclosure and equal justice?

In a statement Goldman says that "The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation." Fabrice Tourre was last seen being thrown under a bus, and could not be reached for comment.

Watch the Justice Department and the Obama Administration to see what they do or do not do, and you will be able to know their character and intents. But in fairness the big Broker-Dealers in the US are RARELY indicted for anything. They virtually own the country's political and justice system.

"I did not run for office to be helping out a bunch of fat cat bankers on Wall Street." Barack Obama to CBS News.

Time do something besides talk the US to death about what you are going to do, and how the Republicans and lobbyists are getting in your way, and how great it will be when you finally do it. The SEC is relatively toothless, and probably by design. The FCIC will be tramping in the weeds for the rest of the year.

You do not need the Republicans, and you do not need the Congress, to fully engage the Justice Department and the FBI in investigating this fraud, Mr. Obama.

The most likely outcome will be a disgorgement of profits and a wristslap, and a promise by Goldman to change its business practices, while admitting no wrong. That will be the 'business as usual' outcome, and a sign that reform is an illusion.

Meanwhile, the market manipulation continues. I thought it was cute the way in which the metals bears used this news to sell the market in an attempt to sustian their huge naked short positions. "Never waste a crisis."

The US Congress reacts to the scandalous news.



Breaking news on breaking the rules, more to follow.

07 April 2010

Derivatives Exposure Among US Commercial Banks


I have not looked at this in some time. The amounts are still quite impressive and highly concentrated in a handful of the TBTF banks.

As in the case of LTCM, leverage is a source of income, the higher the leverage, the greater the profits from which you can claim and take your salaries and bonuses.







Here is how things looked in the middle of 2008 Derivates Report June 30, 2008

19 November 2009

The Partnership Between Wall Street and the Government Will Continue Until the System Collapses?

“Hindsight is a wonderful thing,” said Timothy W. Long, the chief bank
examiner for the Office of the Comptroller of the Currency. “At the height of
the economic boom, to take an aggressive supervisory approach and tell people to
stop lending is hard to do.” Post Mortems Reveal Obvious Risks at Banks, NY Times


Well, the boom is over, so what about now?

The current notional value of derivatives on US commercial banks’ balance sheets is $203 trillion. 97% of these ($196 trillion) sit on FIVE banks’ balance sheets, according to a recent report from that very same Office of the Comptroller of the Currency.

It is obvious from this report that Goldman Sachs is by no means a bank, and deserves no consideration as such. It is a hedge fund. In general, Wall Street is out of control.



Today's testimony by Timmy Geithner in front of the US Congress is interesting to watch. It serves to reinforce my opinion that the Administration is incompetent, caught in old solutions and the status quo, and that the Republican alternative is morally and intellectually bankrupt, given to demagoguery, and owned by a similar but slightly different set of special interests.

Most of the congress are indifferent to the interests of the American people as a whole, whether through self interest or mere cravenness, despite their occasional histrionics for the cameras. It is remarkable how they can act as outraged bystanders, when they have long been at the heart of the corruption and decline. It is their job to manage the government. They have classic American CEO amnesia and 'incredible denial.'

The key to a general reform has been and still is campaign finance reform and a reduction of lobbying payments and campaign contributions as soft bribes to Congress. As the banks cannot regulate and reform themselves, at least according to John Mack's recent advice to the American people, so the Congress and the federal government seem incapable of reforming and managing themselves. If one does it, takes liberties with the law, then they all want to do it to a greater or lesser degree; and in some ways they must if they are to be competitive, if the administration of justice creates the opportunity for selective exceptions, the weakening of regulation.

And too many in the States are yearning for a strong leader, someone who will tell them what to do. A great man, who will exercise authority with a directness and little or no discussion. Someone who will 'put things right.' The primary question seems to be less policy than fashion, whether to wear brown shirts or black, and whether torchlight is too 'retro.'

On a brighter note, the Noveau beaujolais for 2009 is rather nice, dry almost to a fault, but not too tannic. A little more 'fruitiness' would have been a highlight.

11 November 2009

Guest Post: Ralph Cioffi's Acquittal for Fraud - Janet Tavakoli


By Janet Tavakoli of Tavakoli Structured Finance

Ralph Cioffi and Matthew Tannin, former hedge fund managers and co-heads of Bear Stearns Asset Management, were acquitted yesterday (November 10) of all six counts in their fraud trial” U.S. v. Cioffi, 08-CR-00415, U.S. District Court for the Eastern District of New York (Brooklyn).

"I worked at Bear Stearns in the late 1980s and remembered amiable newcomer Ralph Cioffi to be Bear Stearns’ most talented and successful salesman of mortgage-backed securities. He was usually even tempered, always hard working, and thoughtful. I headed marketing for the quantitative group run by both Stanley Diller, one of the original Wall Street “quants,” and Ed Rappa (now CEO of R.W. Pressprich & Co, Inc.), a managing partner. Ralph was a popular salesman with my colleagues and a heavy user of our quantitative research. In gratitude for analytical work that helped him make sales, Ralph presented our group with an $800 portable bond calculator purchased out of his own pocket. When I was lured away from Bear Stearns by Goldman Sachs, Ralph Cioffi tried to persuade me to stay, matching the offer. Around 20 years had passed and since then we occasionally stayed in touch, but we were not close friends.

Among other hedge funds, Bear Stearns Asset Management (BSAM) managed the Bear Stearns High Grade Structured Credit Strategies fund. By August 2006, the fund had a couple of years of double-digit returns. BSAM launched the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage fund taking advantage of the first fund’s “success.”

Both funds managed by BSAM included CDO and CDO-squared tranches backed in part by subprime loans and other securitizations (collateralized loan obligations) backed by corporate loans and leveraged corporate loans. In August 2006 when BSAM was setting up the Enhanced Leverage fund, other hedge fund managers (like John Paulson), shorted subprime-backed investments.

Investors in the two funds managed by BSAM had been getting double digit annualized returns on high-grade debt at a time when treasuries were yielding less than 5 percent. In fixed income investments, that usually means investors are taking risk.

Ralph seemed to have similar views to mine on CPDOs, the leveraged product that I had said did not deserve a AAA rating. Ralph told me he thought the AAA rating could “lull the unsophisticated investor to sleep,” and that for the purposes of his hedge funds, if he liked an investment-grade-rated trade he could have the same trade without paying fees and: “easily lever up … fifteen times.” To paraphrase Warren Buffett, if the price of your investments drops, leverage will compound your misery.

On May 9, 2007, Matt Goldstein called and asked me if I had a chance to look at the registration statement for a new initial public stock offering (IPO) called Everquest Financial, Ltd (Everquest). Everquest is a private company formed in September 2006, and the registration statement was a required filing in preparation for its going public. The shares were held by private equity investors, but the IPO would make shares available to the general public.

Everquest was jointly managed by Bear Stearns Asset Management Inc, and Stone Tower Debt Advisors LLC, an affiliate of Stone Tower Capital LLC. I was curious, but I was swamped. I told him no, I was very busy and had not even had a chance to glance at it. He called again asking if I had seen it, and again I said no, “Go away.” The next morning I ignored Matt’s voice mails, but finally took his call the afternoon of Thursday May 10 telling him that I still had not looked at the registration statement and had no plans to do so that day. My first call on the morning of Friday, May 11, 2007, was again from Matt Goldstein. He thought the IPO might be important.

I went to the SEC’s website, and as I scanned the document I thought to myself: Has Bear Stearns Asset Management completely lost its mind? There is a difference between being clever and being intelligent. As I printed out the document to read it more thoroughly, I put aside the rest of my work and said: “Matt, you are right; this is important.” I was surprised to read that funds managed by BSAM invested in the unrated first loss risk (equity) of CDOs. In my view, the underlying assets were neither suitable nor appropriate investments for the retail market.

I did not have time for a thorough review, so I picked a CDO investment underwritten by Citigroup in March 2007 bearing in mind that if the Everquest IPO came to market, some of the proceeds would pay down Citigroup’s $200 million credit line. Everquest held the “first loss” risk, usually the riskiest of all of the CDO tranches (unless you do a “constellation” type deal with CDO hawala), and it was obvious to me that even the investors in the supposedly safe AAA tranches were in trouble. Time proved my concerns warranted, since the CDO triggered an event of default in February 2008, at which time Standard & Poor’s downgraded even the original safest AAA tranche to junk.

The equity is the investment with the most leverage, the highest nominal return, and is the most difficult to accurately price. The CDO equity investments were from CDOs underwritten by UBS, Citigroup, Merrill, and other investment banks.

Based on what I read, Everquest’s original assets had significant exposure to subprime mortgage loans, and the document disclosed it, “a substantial majority of the [asset-backed] CDOs in which we hold equity have invested primarily in [residential mortgage-backed securities] backed by collateral pools of subprime residential mortgages.” Based on my rough estimates, it was as high as 40 percent to 50 percent.

I explained my concerns to Matt in a general way. Among other concerns: (1) money from the IPO would pay down Everquest’s $200 million line of credit to Citigroup; (2) the loan helped Everquest buy some of its assets including CDOs and a CDO-squared from two hedge funds managed by BSAM, namely the Bear Stearns High-Grade Structured Credit Strategies Fund that had been founded in 2003 and the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund (“Enhanced Leverage Fund”) launched in August 2006; and (3) the assets appeared to include substantial subprime exposure.

Matt Goldstein posted his story on Business Week’s site later that day. Initially it was called: The Everquest IPO: Buyer Beware, but after protests from Bear Stearns Asset Management, Business Week changed the title to Bear Stearns’ Subprime IPO. I hardly think that pleased Bear Stearns more.

Ralph Cioffi contacted me about the Business Week article. He said that dozens of IPOs like Everquest had been done—mostly offshore so as not to deal with the SEC. According to Ralph, BSAM’s hedge funds and Stone Tower’s private equity funds would own about 70 percent of Everquest stock shares (equity), and they had no plans to sell “a single share at the IPO date.” They planned to use the IPO proceeds to pay down the Citigroup credit line and possibly buy out unaffiliated private equity investors.

I responded that verbal assurances that there are no plans to sell a share at the IPO date are meaningless. Publicly traded shares can be sold anytime. But even if the funds kept their controlling shares, it was not good news. Retail investors would have only a minority interest which would be a disadvantage if they had a dispute with the managers.

Ralph claimed that subprime was “actually a very small percent of Everquest’s assets.” He reasoned that on a market value basis the exposure to subprime was actually negative because Everquest hedged its risk. Technically, Ralph might have been correct—but the registration statement for the Everquest IPO itself suggested otherwise: “The hedges will not cover all of our exposure to [securitizations] backed primarily by subprime mortgage loans.”

It is fine to talk about net exposure (left over after you protect yourself with a hedge), but one usually also discusses the gross exposure (of the assets you originally bought). Hedges cost money, so they can reduce returns.

Ralph Cioffi said CDO equity is “freely traded and easily managed.” I countered that CDO equity may be easy for Ralph to value, but investment banks and forensic departments of accounting firms told me they have trouble doing it.

I told him that if this were a CDO private placement, it would have to be sold to sophisticated investors and meet suitability requirements, but since it is in a corporation, it can be issued as an initial public offering (IPO) to the general public. It seemed to be a way around SEC regulations for fixed income securities, and it was not suitable for retail investors in my view.

Ralph said he would talk to his lawyers about changing the IPO’s registration statement to add a line about third party valuations. We seemed to be talking at cross purposes, since the registration statement already said that third party valuation would occur at the time of underwriting. The problem with that was that the assumptions for pricing would be provided by a conflicted manager, and assumptions are critical in determining value. Moreover, on an ongoing basis, one had to rely on a conflicted management’s assumptions for pricing.

Ralph did not seem to want to end the discussion, so I asked him if there was something he wanted me to do. He said it would be great if I issued a comment saying I was quoted “out of context,” that my being quoted in Business Week lent credibility to the article and was not helping me, and that I would be “better served” writing my own commentary. I ignored what I perceived to be a thinly veiled threat. I told him that if he wanted me to write a commentary, I would do a thorough job of raising all of the objections I had just raised with him. Ralph seemed unhappy but my thinking he was a hedge fund manager from Night of the Living Dead was the least of his problems."
Excerpted with permission from the publisher, John Wiley & Sons, from Dear Mr. Buffett, What an Investor Learns 1,269 Miles from Wall Street , by Janet Tavakoli. © 2009 by Janet Tavakoli.


10 October 2009

Beta Monster: The Most Dangerous Banks In the World


The most leveraged bank by far is the-investment-bank-which-must-not-be-named. It is followed by J.P. Morgan on a percentage basis, but JPM is far larger nominally than these charts indicate because of its much larger capital base. Its in the nature of the difference between a cardshark (GS) and a pawnshop (JPM). Or perhaps just the capital requirements of the short versus the long con.

Luckily for the US financial system the big banks are incapable of making errors in risk management, and always seem to get by with a little helpful information from their friends, and a lot of money from the public.

We would ask Timmy for an explanation on how this could happen so soon after a crisis in which the Treasury had to ask Congress to stop financial armageddon overnight because of the perils of excessive leverage on dodgy capital, but he is taking dictation from Lloyd on line 1, and Jamie is on hold on line 2.



31 August 2009

Five Wall Street Banks Seek to Protect Lucrative OTC Derivatives Market


Gottes Mühlen mahlen langsam, mahlen aber trefflich klein
Ob aus Langmut er sich säumet, bringt mit Schärf' er alles ein*.
Friedrich von Logau
This story about the Wall Street lobby was interesting, particularly since this morning Bill Dudley, friend of Wall Street, Goldman alumnus, and President of the NY Fed, called for the continuing purchase of over a trillion dollars in bad mortgage debt from these banks at above market prices here.

And here the Natinoal Association of Business Economists NABE (the Finanz Freikorps) has recommended that there be no new stimulus packages aimed at the public and consumers, who have had enough. In fact, the government should begin to cut spending on public programs.

But not a word about the subsidy to these money addicts, the banks, who use the opaque derivatives markets to widen the spreads on products, to hoodwink the naive and less sophisticated individuals and small towns.

And so Wall Street once again gathers its forces to persuade (provide many millions in donations and soft bribes) to Congress and the Administration.

Do you get the picture yet?

Bloomberg
Wall Street Stealth Lobby Defends $35 Billion Derivatives Haul

By Christine Harper, Matthew Leising and Shannon Harrington

Aug. 31 (Bloomberg) -- Wall Street is suiting up for a battle to protect one of its richest fiefdoms, the $592 trillion over-the-counter derivatives market that is facing the biggest overhaul since its creation 30 years ago.

Five U.S. commercial banks, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Bank of America Corp., are on track to earn more than $35 billion this year trading unregulated derivatives contracts. At stake is how much of that business they and other dealers will be able to keep.

Business models of the larger dealers have such a paucity of opportunities for profit that they have to defend the last great frontier for double-digit, even triple-digit returns,” said Christopher Whalen, managing director of Torrance, California-based Institutional Risk Analytics, which analyzes banks for investors.

The Washington fight, conducted mostly behind closed doors, has been overshadowed by the noisy debate over health care. That’s fine with investment bankers, who for years quietly wielded their financial and lobbying clout on Capitol Hill to kill efforts to regulate derivatives. This time could be different. The reason: widespread public and Congressional anger over the role derivatives such as credit-default swaps played in the worst financial crisis since the Great Depression...

The five biggest derivatives dealers in the U.S. -- JPMorgan, Goldman Sachs, Bank of America, Morgan Stanley and Citigroup Inc. -- held 95 percent of the $291 trillion in notional derivatives value of the country’s 25 largest bank holding companies at the end of the first quarter, according to a report by the Office of the Comptroller of the Currency. More than 90 percent of those derivatives were traded over the counter, the OCC data show...

Obama’s plan deals another blow to banks. It aims to discourage them and their customers from using non-standard, or customized, derivatives that can’t be processed by a clearinghouse or traded on an exchange by requiring that parties to such trades hold more capital to protect themselves against losses. The plan would also require they put up more money, known as margin, to insure they make good on the trades. Both changes would impose added costs on banks and some customers...

The Obama proposals don’t go as far as some people have urged. Hedge fund billionaire George Soros and Berkshire Hathaway Inc. Vice Chairman Charles Munger are among investors who have called for limits on the use of credit-default swaps. Soros wrote in a March 24 Wall Street Journal column that regulators should ban so-called naked swaps, in which the buyer isn’t protecting an existing investment.

Two days later Treasury Secretary Timothy Geithner dismissed such an idea before the House Financial Services Committee, telling members that “my own sense is that banning naked swaps is not necessary and wouldn’t help fundamentally.”

Janet Tavakoli, founder and president of Tavakoli Structured Finance Inc. in Chicago, said in an interview that derivatives have allowed banks to camouflage risk.

“There has been massive widespread abuse of over-the- counter derivatives, which have contributed to transactions that people knew or should have known were overrated and overpriced at the time they came to market,” said Tavakoli, who traded, structured and sold derivatives over more than two decades in the financial industry.

Wall Street is accustomed to getting its way with derivatives legislation. The last major congressional action, in 2000, was designed to exempt over-the-counter derivatives from government oversight...

For Wall Street, the longer it takes to get legislation passed the better. As stock market values and the economy improve, anger at banks is likely to subside...

* "Though the mills of God grind slowly, they grind exceeding fine;
With patience He grinds slowly, with exactness all He finds."


15 July 2009

Derivatives Crisis: More Bailouts On Deck?


The derivatives market is about as ugly as it gets, and puts a new edge on 'too big to fail, to big to exist."

The banks want to keep the game going because it suits their current model of taking risks, making huge bonuses, and writing off the losses to the public.

It remains to be seen if the Obama Administration has what it takes to regulate and rein in the banks. While Larry Summers and Tim Geithner are on the team the answer is probably 'no.'

One thing which strikes us as odd in this Bloomberg article is the emphasizing of stimulus as a source of future crisis. All things considered two trillion in stimulus across the globe is a relative drop in the buck-et compared to what the bank bailouts are costing in direct and indirect taxation on the real economy. Bloomberg seems to be crusading against anyone but the bigh banks getting public money, so perhaps it is not surprising.

As you know, CIT is deeply troubled, and most likely heading towards some sort of managed bankruptcy. The company is said to be holding counter party risk with many banks including Goldman Sachs. The rally may be based on strong rumours of an imminent bailout for CIT. The word on the Street is that Geithner and Summers caved again after a few key phone calls.

Let's see how the Obama Administration handles yet another financial institution brought low by bad risk management in pursuit of outsized profit.

Wall Street and their demimonde in the government and the media hate stimulus packages designed to assist the ordinary Joe, even if all it does is ease the pain during a steep downtrend (which was caused by the financial sector). They hate it, unless there is a way to charge fees in its distribution, and turn it into a profit-making venture for them where they derive most if not all of the benefits.

The dollar and the US bond are taking it repeatedly on the chin. As are most of the US public and the holders of its debt.

The timeframe Mr. Mobius has for the next major crisis is way out on the far edge of any projection we think is probable by quite some distance. Its not clear that it really matters, given the significant hurdles facing the economy this year.

Let's see how the Boys handle the burgeoning Commercial Real Estate, Pension, and Stage Government crises. I think they may very well precede the derivatives coup de grace, and several of them are big enough to be show-stoppers, if not triggers for a larger systemic meltdown.

Until the banks are restrained, and the financial system is reformed, and balanced is restored to the economy, there will be no sustained recovery.

The Obama team is incompetent, and probably worse. Its a great disappointment. They are showing all the wrong moves on the economy.

All the charts included here are from our friends at ContraryInvestor.

Bloomberg
Mobius Says Derivatives, Stimulus to Spark New Crisis

By Kevin Hamlin (Beijing)

July 15 (Bloomberg) -- A new financial crisis will develop from the failure to effectively regulate derivatives and the extra global liquidity from stimulus spending, Templeton Asset Management Ltd.’s Mark Mobius said.

Political pressure from investment banks and all the people that make money in derivatives” will prevent adequate regulation, said Mobius, who oversees $25 billion as executive chairman of Templeton in Singapore. “Definitely we’re going to have another crisis coming down,” he said in a phone interview from Istanbul on July 13.

Derivatives contributed to almost $1.5 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg. Global share markets lost almost half their value last year, shedding $28.7 trillion as investors became risk averse amid a global recession.

The U.S. Justice Department is investigating the market for credit-default swaps, Markit Group Ltd., the data provider majority-owned by Wall Street’s largest banks, said July 13.

Mobius didn’t explain what he thought was needed for effective regulation of derivatives, which are contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather. The Bank for International Settlements estimates outstanding derivatives total $592 trillion, about 10 times global gross domestic product.

Looming Crisis

Banks make so much money with these things that they don’t want transparency because the spreads are so generous when there’s no transparency,” he said.

A “very bad” crisis may emerge within five to seven years as stimulus money adds to financial volatility, Mobius said. Governments have pledged about $2 trillion in stimulus spending.

The Justice Department’s antitrust division sent civil investigative notices this month to banks that own London-based Markit to determine if they have unfair access to price information, according to three people familiar with the matter.

Treasury Secretary Timothy Geithner last week urged Congress to rein in the derivatives market with new U.S. laws that are “difficult to evade.” He said strong capital requirements were the key.

Geithner repeated President Barack Obama’s call to force “standardized” contracts onto exchanges or regulated trading platforms, and regulate all dealers.

Credit Freeze

The plan to regulate the derivatives market is part of a wider overhaul of financial industry rules meant to prevent any possibility of a repeat of last year, when the collapse of Lehman Brothers Holdings Inc. and American International Group Inc. froze credit markets and worsened the global recession.

In the Senate, Agriculture Committee Chairman Tom Harkin, an Iowa Democrat, is pushing for legislation that would require all over-the-counter derivatives trades be traded on regulated exchanges, not just standardized ones as the Obama administration is seeking.

U.K. banks will be forced to curb trading activity that helped cause the global financial crisis, Britain’s top financial regulator said last month, while stopping short of seeking to separate their lending and securities units.

“Banks have lobbied hard against any changes that would make them unable to take the kind of risks they took some time ago,” said Venkatraman Anantha-Nageswaran, global chief investment officer at Bank Julius Baer & Co. in Singapore. “Regulators are not winning the battle yet and I’m not sure if they are making a strong case yet for such changes.”

Mobius also predicted a number of short, “dramatic” corrections in stock markets in the short term, saying that “a 15 to 20 percent correction is nothing when people are nervous.”

Emerging-market stocks “aren’t expensive” and will continue to climb, Mobius said. He said he favors commodities and companies such as London-based Anglo American Plc, which has interests in platinum, gold, diamonds, coal and base metals.

In China and India, Mobius sees value in consumer-oriented stocks and banks, he said.

21 December 2008

The Problems Which Banks Face in a Post Credit Bubble World


Fear and Loathing in Financial Products
Banks – The “V”, “U” or “L” Recovery
By Satyajit Das
December 21, 2008

In 2007, equity markets fell out of love with financial institutions, especially those with large investment banking operations. 2008 saw something of reconciliation - the bigger the write-off, the bigger the dividend cut, the bigger the capital raising, perversely the greater the investor buying interest. By the end of 2008, there seems to have been an irreconciliable breakdown in relationships that no counsellor could fix.

The outlook for banks remains grim.

The asset quality of major banks remains uncertain
. Svein Andresen, secretary general of the Financial Stability Forum, which is made up of global regulators and central bankers, recently told a conference of bankers in Cannes: “We are now 10 months through this crisis and some of the major banks have yet to make disclosure in [crucial] areas.”

Despite significant writedowns, sub-prime assets remain vulnerable. Other assets - consumer credit, SME loans, corporate lending and high yield leverage loans to private equity transactions- all look vulnerable as the real economy slows. Banks have increased provisions but it is not clear whether they will be adequate.

Bank balance sheets have changed significantly. Traditional commercial bank assets consisted primarily of loans and high quality securities. Traditional investment bank assets consisted of government securities and the inventory of trading securities.

In recent years, asset credit quality has deteriorated. High quality borrowers have dis-intermediated the banks financing directly from investors. Banks also hold lower quality assets to boost returns.

Bank balance sheets also now hold investments – private equity stakes, principal investments, hedge fund equity, different slices of risk in structured finance transaction and derivatives (of varying degrees of complexity). Sometimes, the assets don’t appear on balance sheet being held in complex off-balance sheet structures with various components of risk being retained by the bank. Further write-downs in asset values cannot be discounted.

Banks require re-capitalisation. The capital is required to cover losses. Capital is also needed for assets returning onto their balance sheet (as the vehicles of the “shadow banking system” are unwound). This capital is required to restore bank balance sheets. Additional capital will be needed to support future growth. Availability of capital, high cost of new capital and dilution of earnings will impinge upon future performance.

Earning growth in recent years has been driven by a rapid expansion of lending – both traditional and disguised forms such as securitisation and derivatives activity. Bank balance sheets have expanded at rates well above GDP expansion. Lower volumes in the future will mean lower earnings. (The desire for banks to grow profits faster than GDP becomes a drag on the real economy when the financial sector is outsized - Jesse)

Lack of lending capacity may also affect other activities. Corporate finance and advisory fees are driven by the capacity to finance transactions and also co-investing in risk positions. Lower origination of lending driven deals may reduce this income significantly. Banking fees for leveraged finance deals are down 90%.

Structured finance has contributed strongly to earnings in recent years. Securitisation, including CDO activity, has been a major growth area. Volumes have collapsed. The slowdown in structured finance has complex effects. Banks generated large earnings from off balance sheet vehicles in the shadow banking system. The vehicles provided banks with the ability to “park” assets and reduce capital. They also provided significant revenue – management fees; debt issuance fees and trading revenues. Recovery in these earnings is unlikely any time soon.

Trading revenue has been a bright spot. Increased volatility and much wider bid-offer spread have generated increases in both client driven and proprietary trading earnings. Volatility and the need to adjust trading positions created strong trading flows and earnings. As the markets stabilise, trading flows and earnings decline.

Several factors may limit trading income. Derivatives and structured investments, especially complex products, generated significant earnings. Problems in structured finance highlighted concerns about complexity, transparency and valuation. Market volatility has resulted in significant losses in some structured investments. Revenues may diminish as investors and borrowers curtail their use of such instruments preferring simpler products that are less profitable to the bank.

Trading revenues relied heavily on hedge funds and financial sponsors. Hedge fund activity is likely to slow through consolidation, investor redemptions and reduced leverage. Derivatives and hedging activity from private equity transactions and structured finance has been significant. Hedging revenues typically contribute 50% or more of bank earnings from a private equity transaction. Reduction in financial sponsor activity will limit revenue from this source.

Banks have increasingly relied on proprietary trading to supplement earnings. This increases risk and depends on the availability of capital. It relies on availability of counterparties and liquidity. Concern about counterparty risk and reduction in market liquidity in some products increases the risk of this activity and reduces its earning potential.

Future earnings will be affected by the availability of risk capital. The banks may not be able to access capital to the extent needed. The demise of the shadow banking system will mean that purchased capital will not be available. Regulators may also increase capital levels for some transactions exacerbating the capital problem.

Risk models in banks are a function of market volatility. The low volatility regime of recent years reduced the amount of capital needed. Increased market volatility will increase the amount of capital needed. This may restrict the level of risk taking and therefore earnings potential.

Higher costs will also increase limiting earning recovery. Bank funding costs have increased. Most firms have been forced to issue substantial amounts of term debt to fund assets returning to balance sheet and protect against liquidity risk. To the extent, that these costs cannot be passed through to borrowers, the higher funding costs will affect future funding.

Banks have issued high cost equity to re-capitalise their balance sheets. Hybrid capital issues paying between 7.00% and 14.00 % pa will be drag on future earnings. Highly dilutionary equity issues (often at a discount to a share price that had fallen significantly) will impede earnings per share growth and return on capital.

Accounting factors may also affect any earnings recovery. FAS157 allows the entity's own credit risk to be used in establishing the value of its liabilities. Changes in the entity's credit standing are therefore reflected as changes in fair value. This results in gains for credit downgrades and losses for credit upgrades.

As credit spreads increased, banks have taken substantial profits to earnings from revaluing their own liabilities. If markets stabilise and the credit spreads for banks improves then banks will have to reverse these gains. There may be significant mark-to-market losses especially on new debt issues by banks at high credit spreads since mid-2007. Investors are looking for a rapid recovery in bank earnings. Earnings may recover but the “gilded age” of bank profits may be difficult to recapture.

Glamorous banks reliant on “voodoo banking” may find it difficult to achieve the high performance of the “go-go” years. (Goldman Sachs is the poster child - Jesse)

Banks with sound traditional franchises that have avoided the worst excesses of the last 10-15 years will do well in the changed market environment. Such old fashioned banking may ironically do well in the “new” environment. Interest rates that they charge customers have increased. Bank deposits have become far more attractive than other investments. Stronger banks have also benefited from a “flight to quality”.

Will the recovery in bank stocks take the form of “V” or “U”? It may be a “L”. With the Northern Rock and Bear Stearns bailouts, central banks and governments have signaled that major banks are “too big to fail”. This is a necessary but not sufficient condition for recovery of bank earnings and stock prices. The recovery might take the form of a “L” (Kirsten ITC font) – note the small upturn at the far right of the flat bottom.