Category Archives: Finance

What went wrong with AIG’s swaps: risk assessment…

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Daniel Amerman analyzes the the bonus structure that drove bad risk assessment at AIG.

Analysts are in competition with each other to come up with rosier and rosier scenarios, because their bonuses, which they get to take upfront, depend on it. Bad enough, he says, when the underlying securities are mortgage-related. But terminally dangerous when they are corporate derivatives:

“With corporations you need to assess complex financial structures. You need to look at the industry as a whole, assess the relative competitive standing of the company, look at foreign competition, examine comparative growth rates, subjectively evaluate management capabilities, and dive into the footnotes for clues as to pension and health-care exposure, as well as including a wide array of other risks and factors. All of which require using assumptions. Now, as we saw earlier in this article, assumptions are where the money is made when it comes to derivative securities. When we compare the corporate credit derivatives market to the subprime mortgage derivatives market — there is far more room to make money through making aggressive assumptions with corporate derivatives.”

Comment: 

The two major assumptions that analysts at AIG made (because the incentive system encouraged them to) was that there was no danger of a recession and no danger of systemic risk.

Both, as it happened, were disastrously wrong…

End of an Era: Wall Street Caving In

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“Sept. 14 (Bloomberg) — A group of banks including Bank of America, CitiGroup and JPMorgan Chase & Co. are putting up $70 billion for a borrowing fund aimed at providing liquidity… Each participating financial firm will provide $7 billion to establish the fund and have the ability to borrow up to a third of the total. Other banks include Barclays Plc, Credit Suisse Group AG, Deutsche Bank AG, Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co. and UBS AG. The pool could expand as other companies join.

Now, let’s get this straight. Ten banks put up $7 billion for a total of $70 billion. Because any bank can withdraw up to $23.3 billion, if three banks take $23.3 billion each, there will be nothing left for the others. Am I missing something?

There is nothing wrong with the plan, per se. The flaw lies in the flawed character of the participants. These are investment banks and if investment banks can exploit a situation, they will do so. That’s what investment banks do for a living, they exploit situations for their own advantage in order to maximize profits.

Last year when two Bear Stearns highly leveraged funds were in danger of failing, Bear Stearns came to the “rescue” of one of its funds and lent it more capital, albeit with the caveat that Bear now had first claim on the fund’s assets. Then, when the fund collapsed shortly thereafter Bear Stearns exercised its now first-in-line rights to all the assets.

Since self-serving behavior is common among investment bankers, it will be interesting to see how the bankers’ $70 billion fund will fare. After the first withdrawal, there may be a “bank run” on the remaining assets by the remaining banks—a real life version of what will be “the Banker’s Dilemma”.

A FRACTIONAL RESERVE SAFETY NET

The investment banks’ $70 billion liquidity fund is predicated on much the same premise that fractional reserve banking is based. While it is understood there may not be enough in the fund to cover all needs, it is assumed that not everyone one will need their funds at the same time.

This thinking/sic assumption is the basis of today’s fractional reserve banking system; because, as in the banker’s “liquidity plan”, there is not enough money in US banks in the event of significant withdrawals by savers.

There is $6.84 trillion on deposit in US banks; but US banks have only $273.7 billion cash on hand. The banks cannot possibly pay back depositors all their money as only 4 % of depositors’ funds are actually available. The rest has been loaned out, i.e. to real estate developers, etc.

The safety net of both bankers and depositors may prove inadequate in the days ahead. Be forewarned….”

 

More by Darryl Schoon.

Their Man in Africa: Chinese Checkered in Zimbabwe

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And what’s the real deal behind the unrelenting bad press for Robert Mugabe, President of Zimbabwe? (Not that we are Mugabe fans here, but anyone who gets trashed regularly in the mainline…sorry…stream media invites lively curiosity, if not outright solicitousness from us). Well, here’s what:

“In April 2007 the chairman of China’s top political advisory body, Jia Qinglin, head of the National Committee of the Chinese Peoples’ Political Consultative Conference, flew to Harare to meet with Mugabe. It was a follow-up to the 2006 Beijing China-Africa Cooperation Summit where the Chinese government invited the heads of more than 40 African states to discuss relations. Africa has become a diplomatic and economic priority for China and its economy.

At that time, Beijing got an open invitation to help develop dormant mines in the country. The deputy speaker of Zimbabwe’s parliament called for more Chinese investment in the country’s mining sector, according to China’s Xinhua news agency. Zimbabwe’s mining laws were changed to allow the government to reallocate mining claims that were not being exploited.

Mining generates half of Zimbabwe’s export revenue. It is the only sector in the country that still has foreign investors after the collapse of the main agricultural sector. Western companies with mining claims in Zimbabwe were not exploiting them. “We would appeal to the Chinese government to come in full force to exploit these minerals,” Zimbabwean Deputy Parliamentary Speaker, Kumbirai Kangai said to the official Xinhua.

Kangai assured potential Chinese investors that they would not expose themselves to legal action if they took over claims held by Western companies.

A few months after, in December 2007, Chinese company, Sinosteel Corporation, acquired 67 percent stake in Zimbabwe’s leading ferrochrome producer and exporter Zimasco Holdings.Zimasco Holdings is the fifth largest high carbonated ferrochrome producer in the world. It used to produce 210,000 tons of high-carbon ferrochrome per year, nearly all of it along the mineral-rich Great Dyke, accounting for 4 percent of global ferrochrome production.

Zimasco has also the world’s second largest reserves of chrome, after South Africa. It was formerly owned by Union Carbide Corporation, now part of Dow Chemicals Corp.

Oh, oh! Alarm bells went ringing in London and in Washington at that news….”

More by the straight-talking Bill Engdahl.

Financial Follies: The Great American Tsunami

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“As with the Tsunami which devastated Asia in wave after terrifying wave in December 2004, the financial Tsunami we are witnessing is a low-amplitude, long-wave phenomenon of trillions of dollars of financial securities being unwound, defaulted on, dumped on the market. But the scale of the latest wave to hit, the collapse of confidence in the two Government-Sponsored Entities, Freddie Mac and Fannie Mae, is a harbinger of worse to come in what will be the most devastating financial and economic catastrophe in United States history. The impact will be felt globally.”

So says Bill Engdahl

Double-Trouble – An Oil Bubble….

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“As much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds. It has nothing to do with the convenient myths of Peak Oil. It has to do with control of oil and its price. . . . Since the advent of oil futures trading and the two major London and New York oil futures contracts, control of oil prices has left OPEC and gone to Wall Street. It is a classic case of the tail that wags the dog.”[6]

U.S. Representative Bart T. Stupak, Democrat – Michigan, chairman of the subcommittee investigating commodity market speculation, attributes even a higher percentage of the oil price hike to market manipulation: “Speculations now account for about 70% of all benchmark crude trading on the New York Mercantile Exchange, up from 37% in 200.”

Wall Street financial giants that created the Third World debt crisis in the late 1970s and early 1980s, the tech bubble in the 1990s, and the housing bubble in the 2000s are now hard at work creating the oil bubble. By purchasing large numbers of futures contracts, and thereby pushing up futures prices to even higher levels than current prices, speculators have provided a financial incentive for giant futures traders to buy even more oil and place it in storage….”

More at Counterpunch.

Comment:

Ah. Funny how intelligent people can think that the laws of supply and demand can explain the rate oil prices have shot up in the last two months. What a gas, eh?

Makes the environmentalists happy, the luddites chirpy, the nuclear industry and the Pentagon ecstatic and the big government lobby (the entire population) gets to vote in another big-government pol.

Financial Follies: Between the Buck and the Bubble

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“If the Fed raises rates to prevent a sell off in dollars, they’ll crush the highly indebted and already struggling populace and, in so doing, unleash a serious economic crisis. But if the Fed keeps rates where they are, or even lowers them, they’ll trigger a dollar sell-off and unleash a serious economic crisis.

Either way, the story ends the same: a serious economic crisis.

At this point, our bet remains that the Feds will go to default mode which means cranking up the printing presses into the red zone, letting the dollar move ever closer to its intrinsic value: zero. That they’ll follow this route is suggested by two inputs. First, a depreciating dollar means a reduction in the trillions of dollars in obligations now owed by the U.S. government. And, secondly, foreign holders don’t vote.

So, we are calibrating our investments toward a serious economic slowdown, but with high inflation. Some people would call that Stagflation. But given the severity of both sides of that formula, the situation may be better described in terms of Scorched Earth. Or, because people seem to find concepts ending in “flation” handy, Stag-flagration.

Businesses and personal net worth will be devastated at the same time that costs run out of control.

How to Play It?

Our strongest recommendation is to position your portfolio in anticipation of higher inflation and, in time, a turnaround in interest rates. The latter is because interest rates, which are still near a 50-year low, can only go up as the inflation rises to the point of banner headlines (at which point, the government is hoping, the economic downturn will have moderated).

In fact, we think the move towards higher interest rates is a trend that will surprise many, but, once it gets going in earnest (and corporate bond yields are already on the rise) last for at least the next several years.

In terms of other investments, it’s worth noting that in the last major bull market for tangibles, back in the 1970s, oil was the best performing investment, followed by gold, U.S. coins, silver and stamps….”

That’s David Galland, from Casey Research.

Comment:

The buck is doing its old see-sawing on the edge of apocalypse, but having fallen off the cliff over the last year, we still feel inclined to temper our despair with numbers. Here’s an interesting piece that differs from Galland on the dollar:

“The point is that the dollar has been in a negative trend for almost exactly 7 years with the closing peak registered on July 5th of 2001. In the mean time the CRB Index has risen by more than 2 1/2 times. To get to a bottom for the dollar we needed to see some sort of peak in ocean freight rates and a bottom for stocks such as AMGN. The charts on this page make a somewhat tentative case that a trend back towards a sustainably stronger dollar has already begun although quite clearly the DXY will have to rise well above its moving average lines to mark the turn. There are encouraging signs for the dollar which suggest downward pressure on the commodity the theme but it is still much too early to mark this one as paid…”

Kevin Klombies at Inter-Market Relationship.

John Templeton: A Few of His Least Favorite Things

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* Being too optimistic about business ventures

* Relying on any one idea or concept in your investments

*Relying on borrowed money you use for your ventures and assuming that you won’t have to pay it back

John Templeton, who passed away today in the Bahamas, was one of the world’s most successful investors and the three dangers he listed ought to have been nailed on the door of the Federal Reserve. Think about it. His trifecta of over optimism, single-concept thinking, and eternal borrowing just about sums up the mess the US economy is in: how better could you sum up the following:

1. The ‘new economy’ paradigm

2. The wholesale adoption of derivatives

3. The credit-and-leverage bubble.

Sir John had broader interests than finance, of course, which was what made him such a great financial thinker.

As this article in the Wall Street Journal points out, he “forged a union between his progressive investment philosophy and his equally open-minded religious thought.”

He was tolerant.

“I am still an enthusiastic Christian,” Sir John once said. “But why shouldn’t I try to learn more? Why shouldn’t I go to Hindu services? Why shouldn’t I go to Muslim services? If you are not egotistical, you will welcome the opportunity to learn more.”

In 1972, he established the Templeton Prize, the largest annual award given to an individual. Mother Teresa received the first award in 1973. The prize, which in 2009 will be valued at 1 million pounds, or about $2 million, recognizes achievement in work that relates to science, philosophy and spirituality. Its monetary value is always more than the Nobel Prizes — Sir John’s way of demonstrating that spiritual work should not be discounted.

Sir John was knighted by Queen Elizabeth II in 1987 for his philanthropic achievements. That same year he created the foundation, which today has an endowment of about $1.5 billion and awards around $70 million in annual grants. The foundation supports research into fields of science and theology, in keeping with Sir John’s religious values and beliefs.”

Bear Stearns Hedge Managers: Doing The Perp Walk….

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“Two former managers of hedge funds at Bear Stearns were arrested and charged with securities fraud on Thursday, a year after the collapse of the funds signaled the onset of a credit crunch that shows little sign of abating….
The indictments, which will be detailed this afternoon by federal prosecutors in Brooklyn, are the first to be brought against senior Wall Street executives linked to a tight credit market that has rattled global markets, led to more than $350 billion in write-offs, cost numerous executives their jobs and culminated in the demise of Bear Stearns.

The two funds had names as obtuse as the complex subprime securities in their portfolios — High Grade Structured Credit Strategies Fund, and its riskier sister offering, the High Grade Structured Credit Strategies…….”

More at the New York Times.

Comment:

Tut…And these guys were gods only yesterday. How soon they forget….

All it took was for gas prices to double…..and the mob got out the noose and the gallows…

Brazil Booming…

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Lost Your Job on Wall Street? Head for Brazil! PDF Print Mail
27 May 2008
by John Fitzpatrick
The financial crisis which has hit American and European banks has cost tens of thousands of workers their jobs. One side effect of this has been a rise in interest by Western bankers in other markets, particularly in India, the Middle East and the Far East. The Times of London coined the expression summing up the dilemma facing those with no prospects in Western markets: ‘Mumbai, Dubai, Shanghai – or Goodbye”. It quoted a headhunter as saying there had been an annual increase of 20% to 25% in the number of Western bankers heading East over the past two years. So far there has been no sign of many (if any) of these jobseekers heading to Brazil but there are a number of reasons why they should consider the idea.
Any Wall Street whiz kid would feel at home immediately in São Paulo. The city is obsessed with money, success, status and flaunting your wealth. Visit the old downtown area around the Bovespa and BM&F futures exchange, Avenida Paulista, Faria Lima, Funchal, Itaim and Berrini or head further out along the Marginal highway almost as far as Interlagos and you´ll see banks, brokerages, finance houses, insurance companies, accountancy firms, consultancies, actuaries and lawyers´ offices by the score. Countless sky-high buildings, gleaming as the sun reflects their glass exteriors, swarm with hundreds of thousands of busy bees, plugged into their computers, phones glued to ears as they gaze into their computer screens while holding conversations with a dozen people at the same time

Barry Dyke On the Corruption of Bank-owned Life Insurance

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“Barry Dyke, a New Hampshire investment adviser who has studied BOLI, said other banks will likely face losses. “It’s a much bigger issue,” he said.

Bank-owned life insurance had been seen as a safe place for banks to invest their capital but it’s grown increasingly risky, said Dyke, president of Castle Asset Management LLC. “What has happened is banks took a really good thing and corrupted the purpose,” he said.

The insurance writedowns is one of a number of missteps that has plagued Wachovai in recent weeks. It reached a $144 million settlement with regulators over its ties to telemarketers and has said it expects a $1 billion charge in the second quarter because of the accounting of controversial leasing tax shelters.”

More at the Charlotte Observer, from our friend Barry Dyke, whose “Pirates of Manhattan” is selling like hot-dogs at a ball game just off his own website, with no big-time New York agent, no big-time New York publishing house, no big web seller like Amazon, no big bookstore chain like Borders, or anything else but his own lung power on local radio shows. Way to go, Barry.