Only saw a little bit about LCR in coverage of Basel 3, unlike the coverage of capital and exotic debt instruments. Haven’t read a thing about FSA – mostly because I don’t care about the UK terribly much any more and it doesn’t pop up that often in what i read.

Also the little i did read still have a built-in trigger namely the hard barrier on the credit rating of the “risk free” bonds counting towards liquidity.

Cheers anyway for the response, always worth reading!

1) As I said before I find it extraordinary that VaR was used as anything more than a coarse directional heuristic. I can understand the focus from a reg arb point of view. Ditto ratings.

2) The lack of focus on the management of liquidity as a goal in itself. Capital and “profits” are opinion, cash in cash out are facts. It is something that is relatively easy to measure and harder to game on a rolling basis and a liquid bank can sit out short-term blips that a bank with lots of “capital” but no cash cannot. I also see no reason why banks should not be able to show more or less real time info on liquidity to regulators if not publicly. Much more useful CVA than say share price and tends to be more accurate a predictor of stress with less frequent and smaller jumps.

3) Feedback loops. They hedged some of the SS tranches with monolines. Prices decline, monolines have to put up more cash, they get downgraded, hedges are not properly hedged, bank sells causing prices to decline. Rinse and repeat. Same with the wholely artificial banding for credit risk, the static focus on credit risk and regulatory limits on different grades causing unnecessary discontinuous jumps.

Seems to me the last two are really key and barely covered.

Not sure what you mean by the holdings being concealed. ML boasted about it’s warehouse and CDO positions in 2005 and 2006. What was not apparent was the risk they were taking. The desk limits were apparently VaR based without operational limits on the amount of loans taken on. I have to say I find this extraordinary given literally everyone knows the flaws in this methodology, especially for AAA rated FI instruments where the risk is all downside and discontinuous.

I would say that UBS stands to a certain extent as a counterexample to what is claimed here. UBS treasury was compensated on a stand-alone P&L basis and so was incentivised to lodge “excess cash” in higher yielding ABS. Had they had this soft P&L arrangement where they were rewarded for the liquidity they provided to the other bank units they presumably would have focus more on the liquidity than the face yield.

http://www.ubs.com/1/e/investors/release s?newsId=140339

Thanks, DB.

PS worked on a trading desk.

As someone on the sales desk, were you then structuring the very instruments that helped meltdown your economy in the UK? Everyone knew they were bad trades, but as a hot potato, it blew up in the hands of those who couldn’t unload it.

Here’s hoping some of the people involved in risk management or those who knew what was happening start to leak that there was pay off with ‘bonuses’ to look the other way … Bribery by any other name is still bribery.

That said this article is clearly false:

1) It claims this desk was set up to take on extra paper in early 2006 because of the lack of investor demand. The fact is that anyone who claims there was a lack of demand in late 2005- early 2006 is a balls out liar. I would suggest that the writers of this article are simple out of their depth but they have posted “research” that even shows this is simply not true.

2) The desk thought its risk was on the order of tens of millions and were nowhere near breaching their risk limits. The fact that the ACTUAL risk was nowhere is something they only found out long after this event.

3) I have no insider knowledge of this but I can make a pretty good guess what was actually going on. Primary issuance desks like league tables. ML wanted to jump to number one and so “sells” a portion of the paper to this investment desk who in return get a cut of the extra bonus the issuance desk makes due to increased business. That turned out to be a bad deal, they blew up and now are blaming someone else – as by the way are the ML CDO desk.

This story is completely misreported and has nothing to do with “misincentives”.

Is that supposed to be an exoneration? Or an indictment?

ML’s CDO desk is just too stupid to be blameworthy, Felix, stop pointing fingers at underlying structural misincentives! They would have blown themselves up without all the bonuses, so what’s the big deal about the excessive and ridiculous comp plans!?!

It sounds like the ML CDO desk was, at best, grossly incompetent and conflicted by the risk-undermining disconnect between bonus-paying but very risky & ultimately money-losing transactions, and more probably knowing perfidy by using bonuses to lure another in-house ML desk to take on (and thus evade CDO-desk risk limits) known crap that they otherwise wouldn’t have agreed to take on without extra bonuses because it was, in fact, known crap.

Why did ML have $45n of exposure left on their desk to begin with? Anything to do with the fees & bonuses earned on the creation side even after it became apparent that the market didn’t have much appetite for them left?