Commentaries

VW prefs don’t deserve DAX treatment

Volkswagen’s merger with Porsche has exposed a bizzare quirk in the Deutsche Boerse’s index requirements, which could allow the carmaker’s preference shares to replace its ordinaries in the flagship DAX equity index.

Preference shares have no place in blue-chip equity indices. Their dividends must be paid before any distribution to ordinary shareholders, but they have no right to anything further, often lack voting rights, and escape most of the disclosure requirements imposed on ordinary shareholders.

 The latest twist in the VW/Porsche road trip is Qatar’s sale of half of some 50 million VW preference shares it has accumulated. It is concentrating its investment on VW’s ordinary shares, where it is aiming to achieve a holding of 17 percent.

This will mean more than 90 percent of VW’s voting shares will be held by the Porsche clan, the state of Lower Saxony and the Qataris. With a free float of less than 10 percent, the ordinary shares will no longer qualify for DAX inclusion.

But VW’s preference shares could then qualify under the Deutsche Boerse’s rules, assuming their market capitalisation is larger than that of other German companies and the stock is liquid.

However, Qatar’s revelation that it held almost 50 percent of the prefs and is now selling half of them, makes that prospect less likely. The pref shares fell by more than 13 percent as a result of the sale by Qatar Holding, the investment arm of of the country’s sovereign wealth fund.

This has reduced the market value of the prefs for now and would put the prefs behind other prospective DAX entrants such as HeidelbergCement in terms of market capitalisation.

The Credit Crunch Diaries

For many financial services professionals the 2008 credit crisis was about as amusing as the Hundred Years’ War. So it was refreshing to read “The Credit Crunch Diaries” – a humorous account just released by David Lascelles and Nick Carn.

This fictional tale of the meltdown is told in the parallel diaries of the chief executive and compliance officer of a major bank, Amalgamated Finance for Europe. The diaries chart the bank’s journey from reckless lending to government bailout and finally back to business as usual.

The tension between the pheasant-shooting patrician chief executive and the pedantic and earnest compliance office makes an excellent vehicle for comedy – slightly reminiscent the 1980s comedy “Yes Minister.”

Behind the laughs, lies a serious discussion about the failings of risk management at banks, the arrogance of bank executives and the moral hazard created by government bailouts. Compliance office Parquet is comically small minded, boasting in his diary: “It’s more than a year since I put up “WALK – DON’T RUN” notices in all the hallways and I’m pleased to report that the number of collisions between people and trolleys has been halved.” Meanwhile, Gershon is completely devoid of humility. “It’s not often that the jolly old Treasury gives you 10 billion with no expectation of getting it back,” he says. “Just relax. And enjoy it.”

The book ends on a discouraging note, with Gershon quipping that AFFE’s new motto should become “Too Big to Fail.”

Though lighthearted, the book is a powerful critique of the banking industry and government during the financial crisis. If you can stand the occasional rise in blood pressure, it’s well worth a read.

from Rolfe Winkler:

Bookstaber, hater of CDS, to advise SEC

Rick Bookstaber announced on his blog yesterday that he will joining the SEC's "Division of Risk, Strategy and Financial Innovation."

This is a welcome development. Bookstaber is the author of A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.

He was part of an Oxford-style debate on that very subject at the Economist's Buttonwood Gathering last month. I was lucky to be in the audience. Below is the video. (Here's a link too.....go to "debate on financial innovation.")

Watch it through just to see Jeremy Grantham. He was on fire. (His first comments being a third of the way in.) His rhetoric successfully flipped the audience from being 80:20 in favor of the proposition that "financial innovation boosts global growth" to a similar margin against.

It's highly ironic that Myron Scholes was chosen to argue for the proposition. An inventor of the Black-Scholes options pricing model, he was also a partner at LTCM, the famous hedge fund firm that blew itself up mixing mathematical hubris with leverage.

Scholes's life story should be a cautionary tale AGAINST the idea that financial innovation creates great wealth. Yet here he is, having learned nothing.

Not that it's unexpected. Nothing encourages cognitive dissonance quite like the absence of consequences. Bailed out bankers on Wall Street who feel they've "earned" the bonuses they plan to pay themselves this year are just the latest example...

from Rolfe Winkler:

Sander’s TBTF amendment

Now THIS is legislation to get behind. From Senator Bernie Sanders, Independent from VT.

Update: Reader macstibs posts this link to a petition supporting Sanders.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE. This Act may be cited as the ‘‘Too Big to Fail, Too Big to Exist Act’’.

SEC. 2. REPORT TO CONGRESS ON INSTITUTIONS THAT ARE TOO BIG TO FAIL.

Notwithstanding any other provision of law, not later than 90 days after the date of enactment of this Act, the Secretary of the Treasury shall submit to Congress a list of all commercial banks, investment banks, hedge funds, and insurance companies that the Secretary believes are too big to fail (in this Act referred to as the ‘‘Too Big to Fail List’’).

SEC. 3. BREAKING-UP TOO BIG TO FAIL INSTITUTIONS. Notwithstanding any other provision of law, beginning 1 year after the date of enactment of this Act, the Secretary of the Treasury shall break up entities included on the Too Big To Fail List, so that their failure would no longer cause a catastrophic effect on the United States or global economy without a taxpayer bailout.

SEC. 4. DEFINITION. For purposes of this Act, the term ‘‘Too Big to Fail’’ means any entity that has grown so large that its failure would have a catastrophic effect on the stability of either the financial system or the United States economy without substantial Government assistance.

Points for simplicity, though this doesn't deal with the problem of complexity in financial markets. Still, it's a good start.

Rob Cox of BreakingViews notes the obvious irony here: Socialist Senator proposes most capitalist bill.

I doubt Kanjorksi's amendment, when it surfaces, will be quite this blunt. My guess is it will lean more heavily on regulator discretion.

Should he stay or should he go? Miliband ponders

Should he stay or should he go?

British Foreign Secretary David Miliband could be Europe’s first foreign minister in all but name, with one of the most influential jobs in shaping the place of the 27-nation bloc on the world stage, if he is willing to risk leaving British politics for the next five years. That’s a big if.

Miliband is half of a “ticket” concocted by French and German diplomats to fill the two new top jobs created by the Lisbon treaty. The other half is Belgian Prime Minister Herman van Rompuy, the preferred candidate for president of the European Council. Officially, Miliband says he is ”not available” and is backing Tony Blair’s forlorn bid for the presidency. If he turns the role down, it could well to go to former Italian Prime Minister Massimo d’Alema.

The High Representative for foreign and security policy, with a big diplomatic staff, a multi-billion-euro budget and the additional position of senior vice-president of the European Commission, will arguably be more powerful than the European Council president, whose role is largely to prepare and chair quarterly summits. Miliband would bring dynamism, an incisive intellect and inspiring oratory to the job.

At 44, he is seen as the natural next leader of the Labour Party if, as expected, Gordon Brown loses the next general election. Given the average length of Britain’s political cycle since the 1980s, the centre-left party probably faces at least two parliamentary terms in opposition – roughly eight years. So Miliband would have time to burnish his international credentials in Brussels and return home before he turns 50, and before Labour has exited the political wilderness.

Another former Labour leader, Harold Wilson, famously said that a week is a long time in politics. Five years is an age. Other Labour politicians will fill the vacuum left by Miliband if he decamps to the continent. They may be less talented, but no one is likely to placidly keep the opposition leader’s seat warm until he is ready to make a triumphant comeback.

And don’t rule out smaller short-term considerations. A Miliband departure would cause an unwelcome by-election for Labour before the next general election.

What banks can learn from hedge funds

Should the banking industry look more like the hedge fund sector? That’s the surprising suggestion made last week by two Bank of England officials.

In a fascinating paper, Piergiorgio Alessandri and Andrew Haldane explore the level of public support given to banks in the crisis and the problem of institutions that are too big too fail. Their main point is that if this issue is not addressed it will lead to new crises and even bigger bailouts in the future – a state of affairs they describe as a “doom loop”.

But the most eye-catching passage is a suggestion that banks have a lot to learn from hedge funds:

It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of “highly-leveraged institutions”, most hedge funds today operate with leverage less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system.

This is quite a change of heart. Until a few years ago, regulators viewed hedge funds as the main threat to financial stability. These fears have proved unfounded. Though plenty of hedge funds have blown up – or turned out to be massive frauds – none has so far threatened to drag down the system.

Some things that currently take place in banks are probably better suited to hedge fund structures. Proprietary trading is a prime candidate. There is also a strong case to be made for private partnerships. Would investment banks have grown so large if they were owned by partners who were exposed to any losses?

Even so, it seems fanciful to suggest that the hedge fund model is better. Banks fund themselves by taking retail deposits that customers believe to be safe. That precisely the reason they are so heavily regulated. Hedge funds raise money from institutional investors and wealthy individuals who – in theory at least – realise they could lose it all. Without deposit insurance, the failure of a bank can spark a loss of confidence across the industry. The failure of a hedge fund is less likely to have systemic consequences.

from Rolfe Winkler:

Lunchtime Links 11-8

The economics of trust (Harford, Forbes) A great article. I've argued that markets need rules because without them the division of labor breaks down.

Big bank break up idea gains ground in Congress (Drawbaugh, Reuters) Senator Sanders just introduced a bill to do that. As noted earlier, Kanjorski is working on amendment to do same.

Treasury to block sale of Fannie Mae tax credits to Goldman (Reuters)

Hedge fund giant surfaces in insider trading probe (Pulliam, WSJ) Steve Cohen's SAC Capital is now under the microscope.

Einhorn: first let's kill all CDS (NakedCapitalsim) The post refers to comments from Einhorn's speech at VIC, but expands on it nicely, arguing among other things, that these financial weapons of mass destruction probably can't be made safe no matter how aggressively you regulate them...

Michael Jackson's father seeks allowance from dead son's estate (BBC) His expenses are $20k per month, but he only gets $1700 from Social Security.

Why doesn't exercise lead to weight loss? (Reynolds, NYT)

from Rolfe Winkler:

Amendment could neuter FASB

Sarbox isn't the only regulatory regime under threat. As Ryan Grim writes over at HuffPo, an amendment has been introduced that would put FASB under the thumb of the new systemic risk oversight council, and give the council the power to literally do away with inconvenient accounting rules that pose a problem for banks.

Astonishingly, at a time when the public is crying out for greater regulation to limit excessive risk-taking by financial institutions, the banks are trying to get Congress to agree that the next time there's a big downturn, they should have the ability to alter their accounting standards -- essentially, fudge the numbers -- so that the public and investors won't be able to tell how insolvent they really are. By ignoring their declining asset values, they can avoid the standard requirement of raising more capital.

The mechanism is contained in an amendment set to be introduced in mid-November by Rep. Ed Perlmutter (D-Colo.) that would move final authority over the Financial Accounting Standards Board (FASB) from the Securities and Exchange Commission to a new body, a so-called "oversight" board, that would include the officials charged with managing systemic risks to the financial markets.

Accountants are apoplectic. Even the Chamber of Commerce is fighting this, on behalf of their non-bank membership, co-signing a letter with the Center for Audit Quality and the Council of Institutional Investors:

By placing the FASB under the jurisdiction of a structure charged with managing systemic risks to the financial markets, accounting rules will be viewed though the narrow lens of a few large companies from specific industries, rather than considerate of the applicability of financial reporting policies to over 15,000 public companies. Such a narrow focus can skew standards such that it makes understanding of transactions that businesses engage in on a daily basis more difficult and undermine the confidence of investors. We believe that the SEC has been and continues to be best suited to provide the oversight of the FASB for such a broad and diverse economy.

As such, we strongly support an independent standards-setting process, subject to public scrutiny and free of undue pressures.

Another helpful bit of the article explains how it isn't Wall Street driving this, it's smaller community banks.

It bothers me how small banks have been able to set themselves up as David to the Wall St. Goliath. No, they don't benefit from TBTF guarantees so, yes, they are at a disadvantage relative to Wall St.

But that's not a reason to bend the rules in their favor. No they didn't get involved in more exotic products that blew up Wall St., but many got caught in the CRE mania. If they are insolvent, they need to be shut down. Otherwise they'll continue to absorb capital that should go to solvent banks and borrowers.

from Rolfe Winkler:

Bank failure Friday

As per usual, we begin in Georgia. The last one of the night is a big one.

#116

• Failed bank: United Security Bank, Sparta GA
• Acquiring bank: Ameris Bank, Moultrie GA
• Vitals: as of 9/14/09, assets of $157m, deposits of $150m
• DIF damage: $58 million

Ameris Bank also bought American United two weeks ago.

#117

• Failed bank: Home Federal Savings Bank, Detroit MI
• Acquiring bank: Liberty Bank and Trust, New Orleans LA
• Vitals: as of 9/24/09, assets of $14.9m, deposits of $12.8m
• DIF damage: $5.4 million

#118

from Rolfe Winkler:

Lunchtime Links 11-6

Fannie asks for another $15 billion (press release) That brings the company's total draw on Treasury to $59.9 billion. Here's the paragraph that scares me: "Total nonperforming loans in our guaranty book of business were $198.3 billion, compared with $171.0 billion on June 30, 2009, and $119.2 billion on December 31, 2008. The carrying value of our foreclosed properties was $7.3 billion, compared with $6.2 billion on June 30, 2009, and $6.6 billion on December 31, 2008." Why is the value of nonperforming loans growing so much faster than foreclosures? If Fannie's not going to foreclose, then why bother paying the mortgage?

Fannie owed $15.8 billion by Lehman (Fannie 10-q) see page 103.

With tax break, a bigger carbon footprint (Glaeser, Boston Globe) "The real problem with the [home buyer tax] credit is that it continues the long-standing federal push toward far-flung McMansions and away from dense, apartment living." It's not just about carbon consumption. It's about encouraging the expansion of a footprint that our incomes can no longer support.

Goodbye to reforms of 2002 (Norris, NYT) Floyd chimes in on Sarbox.

Pre-retirees in denial on savings (CalculatedRisk) Future generations (including mine) will look back in wonder at the 20-year retirements that were typical through the 80s/90s/00s.

950th time is the charm for learner driver (Couzens, Sky News, ht Troy M) Is this multiple choice? Surely a monkey filling ovals at random would have managed the necessary 60% at some point. Nevermind that the questions can't change all that often. A regular should figure out the right answers by a simple process of elimination...

Student stuns Iran by criticizing Ayatollah Khamenei to his face (Faramarzi, AP)