Opinion

Felix Salmon

Counterparties

Nick Rizzo
Sep 21, 2011 02:29 UTC

Excerpts from Ron Suskind’s new book somewhat damn Obama’s economic team — Brad Delong

“Shame, fear, pride, dignity” – Greek suicide rates are up 40% — WSJ

Miami has been invaded by giant, house-eating snails — NPR

Perhaps raising taxes on the rich won’t harm unemployment — Center for American Progress

The IMF cuts growth projections for, well, everywhere — IMF

Slovenia’s government has fallen. This delays and jeopardizes the EU bailout — Businessweek

It’s bankers versus traders at Morgan Stanley — Bloomberg

The SEC’s former general counsel may face criminal charges related to Madoff — NYT

This Amazon.com warehouse is a 21st Century version of The JungleAllentown Morning Call

Citi mailed out more credit cards last quarter than there are people in America — WSJ

COMMENT

The CAP argument is pretty bad, as it’s hard to compare 1960s America with the great recession and call them equals.

Posted by djiddish98 | Report as abusive

Munchau: “we are moving closer towards an involuntary break-up”

Sep 20, 2011 20:12 UTC

This post originally appeared on Edward Harrison’s blog Credit Writedowns

I just want to highlight three things here from Wolfgang Munchau on the euro zone because he reaches conclusions I have reached.

In an FT article with the pro-European title of “Eurobonds and fiscal union are the only way out”, Munchau writes about a Greek default:

In Berlin, there is now a consensus among senior policymakers that Greece is very likely to default inside the eurozone, but not right away. By the time it happens, the European financial stability facility will be empowered to protect European banks directly. Those who advocate this approach clearly hope that the improved institutional set-up will be sufficient to deal with contagion.

That’s exactly right. There is no stomach for a full fiscal union. That’s not going to happen. Moreover, Germany is preparing for Greek bankruptcy. The markets see this as a near certainty, so it makes sense to get out in front of the event. What Germany wants is an ‘orderly’ bankruptcy, whatever that means. It’s not clear any default will be orderly, but at a minimum the Germans want to be well-prepared and that means extend and pretend.

Munchau also writes about Italian solvency:

The EFSF and its successor, the European Stability Mechanism, have been set up to handle small countries. They are not big enough to handle large countries. Besides, Italy does not have a short-term funding gap, but a long-term solvency problem. With debt of 120 per cent of gross domestic product, a potential real economic growth rate of around 1 per cent, and a long-term interest rate of 5-6 per cent, Italy’s debt sustainability is in doubt. A monetary union, which solves crises through a combination of default and backstops for the financial sector, would hardly solve Italy’s problem.

Yes, the European Sovereign Debt Crisis is a solvency crisis. My version of what Munchau writes is this:

Is it debatable whether Italy is solvent longer-term? Sure. That’s why Italy is under attack. But the right way to deal with this is to stop the panic and address the issues that could lead to longer-term insolvency. Remember, Italy has a primary surplus. It is high debt and interest costs plus slow growth which are Italy’s problems.

Bottom line: without growth or fiscal surpluses, Italy’s debt to GDP grows. That’s how the numbers work. Miraculous growth is not going to happen for demographic reasons (Italy is old). So you have to see cuts to get the debt levels down.

Finally, there’s the money quote. Munchau writes about the dissolution of the euro zone:

The ruling of the German constitutional court has raised legislative hurdles, while political hostility is rising. We are moving away from what I consider the only effective solution to the crisis. This means, by extension, that we are moving closer towards an involuntary break-up.

My version of why a breakup of the euro zone is likely:

This ruling by the German Constitutional Court does allow the EFSF to operate as planned. Most commentators have focused on this. However, the language of the decision means there can be no eurobonds and no “supra-national” fiscal agent because these are in violation of the German constitution.

[…]

In my view, eurobonds and a “supra-national” fiscal agent are almost the only mechanisms which make the euro zone viable. Therefore, with these options now excluded, the euro zone is almost doomed to failure. The euro zone double dip is almost here and I think that spells bailout fatigue, austerity fatigue, default, and political unrest which will break the euro zone apart.

Does anyone have a different view? If so, please post it in the comments.

Feel free to make comments on the original post.

COMMENT

The only benefit to Greece of leaving the Euro would be it could devalue its then currency. However, the costs would be enormous, and legally it could only leave the Euro by leaving the EU. On leaving, all the various positions of Greek debt in Euros would come under considerable pressure, particularly the French banks, but also all the banks in all the EU area as there would be some domino stacking effects eg British and German banks with holdings in French banks would lose as well as the French banks; this would knock on around the world with another – and much bigger – bank crisis.

Why would Greek default be a bad thing? If it is replaced with longer term debt underwritten by stronger partners and the liquidity issue has already been addressed, what can be bad about a Greek default?

Posted by FifthDecade | Report as abusive

Full Tilt Ponzi

Felix Salmon
Sep 20, 2011 18:55 UTC

Is Full Tilt Poker a Ponzi? It certainly looks that way after reading the official FullTiltPokerComplaint.pdf from the US Attorney. And the perpetrators include two of the best-known poker players in the world — Howard Lederer and Chris Ferguson.

The complaint is long and not particularly interesting; the juicy bits are actually quite short. The meat is here:

According to a balance sheet prepared by Full Tilt Poker, as of March 31, 2011, Full Tilt Poker owed players from around the world over approximately $390,695,788 but had only approximately $59,579,413 in its bank accounts. Full Tilt Poker relied on new deposits from players to ensure its ability to fund withdrawals to players’ accounts.

Rather than protect player funds as promised, Full Tilt Poker distributed hundreds of millions of dollars to its owners…

Defendant Lederer personally received at least approximately $42 million, including approximately $37,856,010.92 in ownership distributions and at least $4 million in “profit sharing” payments…

Defendant Ferguson was allocated approximately $85,161,305.88 in distributions. Tiltware records reflect that approximately $25 million of this sum was actually transferred to Ferguson’s personal accounts, with the remaining balance characterized as “owed” to Ferguson.

Full Tilt Poker said repeatedly and vehemently that players’ funds were kept strictly segregated; this, it seems, was a bald-faced lie. Instead, those funds were intermingled with everything else. As any banker will tell you, deposits are liabilities, but Full Tilt Poker treated deposits as assets, handing them out to its shareholders and counting on two things to keep its business going: the fact that most people lose at poker, and a continued inflow of new funds to help pay the players cashing out.

In a weird way, strict anti-gambling regulations in the US are responsible for this fiasco. If poker sites were legal and regulated, we could trust the regulator — an arm of the US government — to protect gamblers’ funds. Casinos are strictly regulated; online poker sites should be as well. Instead, they became international fugitives, going to great lengths to make it possible for US gamblers to skirt regulations and use their sites. Up to and including buying banks:

In or around September 2009, Elie, together with Andrew Thornhill and a partner of Elie’s (“Elie’s Partner”) approached Campos, the defendant, the Vice Chairman of the Board and part-owner of SunFirst Bank, a small, private bank based in Saint George, Utah. Campos, while expressing “trepidations” about gambling processing, proposed in a September 23, 2009 e-mail to accept such processing in return for a $10 million investment… On or about November 29, 2009, Andrew Thornhill told an associate “things are going well with the bank we purchased in Utah and my colleagues and I are looking to purchase another bank for the purpose of repeating our business plan. We probably could do this for a grand total of 3 or 4 banks.”

Back in May, I attempted a defense of the online-poker crackdown. But there was lots of very smart pushback in the comments, and now this news is more than enough to make me change my mind. If you need to be conducting all manner of wire fraud and money laundering just to stay in business, it’s a relatively small step to going Full Ponzi. On the evidence in the complaint, Lederer and Ferguson were willing accomplices in a scheme which ended up stealing hundreds of millions of dollars from poker players around the world; I wouldn’t be at all surprised to see criminal indictments coming soon. Would they have preferred to be able to set up an entirely legitimate, regulated company? I suspect they would have jumped at any such opportunity.

But now that it seems that even the most respectable poker sites were run by criminals, the chances of that happening are more remote than ever. If you want to play poker for money, go to a casino. Because there’s simply no way of being able to tell whether the site you’re on is a Ponzi.

COMMENT

Wow, shocking. When you criminalize something, it’s run by criminal enterprises with little regard for the well-being of its customers. If only there was some sort of precedent in history we could have used to foresee this, like the criminalization of alcohol or marijuana.

Posted by Nathan_514 | Report as abusive

Felix Salmon smackdown watch, Netflix edition

Felix Salmon
Sep 20, 2011 17:40 UTC

Christopher Mims makes a really good point:

It makes no sense that writers like Felix Salmon, who is generally excellent on just about everything, describe Netfilx, even pre-split Netflix, as an inexpensive alternative to cable. It’s not. It’s only inexpensive if you take fast broadband at home for granted — you know, like every tech pundit and journalist on the planet.

To be fair, it’s a mistake all of those pundits makes regularly — the conflation of their own situation with that of the wider public. But only one in three Americans pays for broadband, which means that something like two-thirds of the population has access to it. That’s not bad (it’s not great either – it puts us something like 27th in world broadband penetration) and it leaves out precisely the people who are being left behind by both our economy and the digital divide.

I moved to the US before the rollout of the cable modem, and for me it was a game-changer: within a few months of its arrival, sometime in the late 90s, I switched from cable-and-no-broadband to broadband-and-no-cable. I was one of the earliest cord-cutters, long before YouTube or Netflix or any real video content on the web which I had any desire to watch. I didn’t want to watch TV on my computer: I just preferred content online to the content on the TV.

Now, over a decade later, it’s possible to look at the population more broadly, and see how their preferences have revealed themselves. And Mims is right: if you have a cable line coming into your home, you’re much more likely to have cable-and-no-broadband than you are to have broadband-and-no-cable. Cord-cutting was a privileged, yuppie behavior when I did it in the 90s, and it remains a privileged yuppie behavior today.* Sure, I like having an extra $100 in my wallet every month due to the fact that I don’t have cable. But I could easily afford it if I wanted it — the fact is that I stopped watching cable long before I cut that cord.

For the time being, the price of broadband — largely set by cable companies — is being set high enough that cable-but-no-broadband subscribers are not switching to broadband-but-no-cable. In order to cut the cord, it seems, you need broadband first: you need cable and broadband, and then you need to come to the decision that you can do without the cable bit.

So, yes, let’s slow down on visions of free or cheap online services supplanting cable for America’s poor. Because Mims is right: broadband is not free. And the cost of Netflix is therefore comparable to the cost of cable — with no live-TV services at all, and in general a much narrower selection of things to watch. At some point, I’m convinced that IP-based video will indeed replace cable. But in order for it to do so, the cost of broadband is going to have to come down. And that doesn’t look as though it’s going to happen any time soon.

*Update: What I mean here is that the behavior is displayed by privileged yuppies, not that it’s inherently yuppie. The kind of people I’m talking about are people who, given the choice between a lean-forward activity and a lean-back activity, tend to choose the former. Either because they prefer surfing the internet to channel surfing, or else because they have work to do online. Those people tend to be part of the employed-and-educated middle classes.

COMMENT

though i appreciate breaking the cable habit, but soon they will consider paying to watch their content…otherwise i’m with felix
until then rediscover the locals with an antenna and receiver.

Posted by 1richardcavessa | Report as abusive

Counterparties

Nick Rizzo
Sep 20, 2011 00:16 UTC

News International will pay $4.7 million to the family of the murdered girl it “allegedly” phone-hacked – Reuters

Advanced degree holders were the only Americans who saw wage growth in the last decade — WSJ Real Time Economics

70 percent of all tax filers receive no benefit from the mortgage interest deduction — NYT

“Every 2 minutes today we snap as many photos as the whole of humanity took in the 1800s.” — Gizmodo

I know of several NYC investors who are kicking the tires on Rat Island, available for under $300K — Curbed NY

Greek Finance Minister: Greece has been “blackmailed and humiliated” by EU and IMF demands — BBC

Paul Volcker: Don’t listen to the “siren song” of boosting inflation. Of course he thinks that — NYT

Larry Summers: Europe must move away from “grudging incrementalism” — Reuters

And Tony Blair reportedly visited Libya several times to lobby for JP Morgan — Telegraph

COMMENT

Yes I made some assumptions. Glad someone is paying attention!

Among the 50% who pay no income tax at all, I expect that most owe no tax because of their income level and the standard deduction and deductions for dependents and earned income etc. Few who itemize bring their tax all the way to zero by doing so. Assuming up to 9.99% of the filers who owe no tax, owe no tax specifically due to itemizing AND M.I.D. and not due to the other reasons, then it is still true that at least 45.01% of filers would owe no income tax regardless.

Then it would still be the case that of the half of filers who actually owe an income tax, a majority benefit from the M.I.D.

If some large percentage of people is bringing their tax down to all the way to zero specifically due to the M.I.D., then my statement is false, but I doubt it. The standard deduction and dependent detections are substantial and most people don’t have both a low income and an expensive house (if they own a house at all) to give a high M.I.D.

Posted by DanHess | Report as abusive

Why we’re in the dark about the mortgage market

Sep 19, 2011 21:01 UTC

By Ryan McCarthy

We have a severe shortage of information about a $10.5 trillion market.

Jesse Eisinger has a great column at ProPublica about just how inscrutable bank data is — if you haven’t read it, you should. A short summary: even the simplest of big bank statements amount to “guesswork,” Eisinger writes.

Eisinger’s one of a precious few writers who’ve been frank about the banking industry’s black box of data. Read enough of Eisinger or Bloomberg’s Jonathan Weil, you begin to suspect that if analysts, reporters and executives were to be honest, they’d admit there is no reasonable way for even trained investors to make an accurate judgement on the health of a large bank. Here’s Eisinger (and you can almost feel the strain from reading SEC documents):

Day after day, [banks] push out news releases that run to dozens of pages. They prepare reams of special presentations for investors, the most recent of which from Wells ran to 51 pages, on top of a 41-page news release. The SEC filing from the quarter was 162 pages.

The numbers and presentation differ slightly in all of them and often differ from other banks’ presentations, stirring a struggle among outsiders to compare apples and bananas. No professional admits this publicly, but many investors and analysts privately acknowledge that they can’t fully track the data gushing each quarter from the nation’s banks.

And while bank disclosures are intelligible only for those versed in financial arcana, there’s one indicator of banking system’s health that may be even more inscrutable: mortgage servicing.

Bad mortgages and shoddy foreclosures have cost America’s five biggest banks as much as $66 billion, according to a recent estimate by Bloomberg. Assuming we’d be able to put aside concerns about the legality of foreclosures — and that’s a big if — you’d be hard pressed to find recent and reliable specifics about how our banks are actually dealing with bad loans.

Whether you’re a prospective home buyer, a struggling mortgage borrower, or an investor, good luck finding any useful information about whether banks are changing mortgage terms, kicking homeowners out or stalling for time.

Take Fannie Mae, for example, which last week released the results of its “Servicer Total Achievement and Rewards” (STAR) program for the first half of the year. The program is designed to provide “clear expectations and specific, consistent measurements to help Fannie Mae servicers increase their focus on areas of critical importance to Fannie Mae,” according to a release.

Fannie Mae, which has not made data behind its criteria STAR criteria public, has an odd way of describing banks’ mortgage servicing performance. There are 11 big banks in “Peer Group 1,” but Fannie Mae names only five — the ones that are performing at least at the median level. It doesn’t tell you whether any of those banks are particularly good, and it doesn’t even name the six banks which are below the median.

(Bloomberg, in this piece, did the easy deduction work that Bank of America and JPMorgan, America’s two largest banks by assets, are on pace to flunk Fannie’s test.)

More helpful are Fannie and Freddie’s new mortgage servicing standards, which are set to go into effect on October 1 and were devised in coordination with FHFA. The agreements fine or reward servicers, according to how they perform. But again, Fannie Mae has no plans to release the names of banks that are being fined or rewarded.

And then newly-launched, Consumer Financial Protection Bureau is reportedly hoping to introduce its own mortgage servcing standards; how those might work is anybody’s guess.

Confused yet?

Well, we haven’t even gotten to the various state foreclosure rules or the Obama administration’s Home Affordable Mortgage Program (HAMP), which was intended to help 3-4 millon homeowners by 2012. To date approximately 800,000 homeowners have received permanent help from HAMP, and the program has been widely declared a failure.

In the Treasury Department’s HAMP reports, you can see for example, that Bank of America only has 132,000 mortgages in that have received “Active Permanent Modifications” through July. And you can see that Bank of America has historically some of the lowest conversion rates among major banks.

This could give us some useful information — but HAMP only accounts for only a fraction of bad mortgages. For context, there are some 4.38 million delinquent home loans in America and another 2 million or so in foreclosure process, according to Lender Processing Services.

There are other places to look for mortgage servicing data. The OCC releases a quarterly mortgage metrics report, which doesn’t break down performance by servicer. The credit rating agencies have their own reports. Or, if you’ve got some cash on hand you can pay for reports from Lender Processing Services or other data providers. (A variety of state agencies and consumer groups also provide some of this data.)

What we need is a centralized repository for all mortgage servicing data — if we can’t see what the problem is, we’ll never find a solution. But as reports pile up that banks are still rubber-stamping possibly illegal foreclosures, if you want to get a sense of how the housing market is doing, you’re probably better off asking your neighbor than consulting the public record.

COMMENT

“Are banks hard to analyse? Yes because they are large complicated multinationals. Are they harder than say GE or Oracle? No.”

Danny_Black, I would disagree…

* Banks are opaque to the common investor. The numbers that really matter for their financial health are deeply subjective and frequently mis-represented by management. Other businesses are driven by a combination of revenues and profitability, both of which are pretty straightforward to assess.

* Banks are highly leveraged. Always makes a business trickier to analyze, since errors in estimation are magnified.

* Banks are significantly impacted by regulatory policy, more so than most businesses. Again, hard to determine what the Fed will decide to do to your investment.

While GE includes a pretty large bank, it at least has significant other operations that are easier to figure out.

Posted by TFF | Report as abusive

Everyone into the next shadow banking system

Sep 19, 2011 20:22 UTC

By Barbara Kiviat

Consumer advocates have been worrying for a while now that the rapid rise of reloadable prepaid cards will lead to a two-tier financial system. There will be folks with bank accounts, and then there will be folks with prepaid cards.

Prepaid cards, which consumers (or their employers) load with money for debit-card-like spending, may  seem like the perfect solution for the 17 million American adults without a bank account—no carrying around wads of cash, no pesky check-cashing fees—but prepaid cards are hardly little angels. They often come with significant fees, including ones to use ATMs, to put more money on the card, and to close out the account. Plus, they tend not to have handy devices, like account statements, that people with bank accounts rely on.

This has led to calls to more closely regulate the industry.

One of the biggest issues is that, unlike bank accounts, prepaid cards don’t necessarily come with FDIC insurance or the protections of the Electronic Funds Transfer Act. To be clear: many prepaid cards do carry “pass-through” FDIC insurance, and some prepaid cards do fall under Reg E, thus carrying consumer protections like limited liability for lost or stolen cards. But the regulation of prepaid cards is patchwork, much of the compliance is voluntary, and consumers are almost certainly not shopping around based on which cards are covered. In many cases, consumers wouldn’t get to pick which card they use anyway, since their employer or government is the one putting money on the thing.

Typically, when people talk about these facts, the conversation is framed as being about the “unbanked,” the low-income, or those out of the “financial mainstream.”

But maybe it’s time we think a little more broadly about prepaid cards.

Since signing up to guest blog while Felix is on vacation, I’ve started doing things like reading wire stories about what MasterCard executives have to say to investors. This Dow Jones piece provides the following nugget:

MasterCard also is pushing its prepaid card business to spur growth.

Prepaid cards, which traditionally have been offered to low-income or “underbanked” consumers, are also a focus.

Increasingly, interest in prepaid cards “will be driven by banked consumers looking” to divide up and budget their spending, Murphy said.

In other words, prepaid cards are on their way into the financial mainstream.

The MasterCard execs point out a demand-side reason for the expansion: using a series of prepaid cards can be a useful way to set aside different pots of money for different uses. It’s mental accounting come to life. I’ve heard about people doing this—even buying prepaid cards specifically to store them away as savings—but I’m guessing what will have much more of an impact on the size and reach of the prepaid industry is the insane marketing muscle of firms like MasterCard.

Anyway, none of that is necessarily bad. Fifty years ago credit cards were the new kid on the block, and 30 years ago hardly anyone was using an ATM. New financial products can be useful, even life-changing.

But there are real reasons why current mainstream products typically come with substantial consumer protections. If the future is one in which we’re all using prepaid cards, perhaps more than those looking out for the “unbanked” should be paying attention.

COMMENT

Prepaid cards are issued by banks, not by some alternative financial services providers. “Prepaid” is actually a pretty bad adjective. Even checking accounts are “prepaid”: try spending money out of a checking account without having deposited some money in it first!

One of the reasons prepaid cards are gaining ground is that the corresponding accounts held by the issuing banks are usually “co-mingled” into a single very large account, making them somewhat cheaper for the banks to operate (than individual checking accounts)
The vast majority of banks hosting prepaid card accounts provide “pass through” FDIC insurance, providing the same protection as individual checking accounts.
And now, for prepaid cards to receive deposits from federal or state sources (tax refunds, benefits…), they must comply with Regulation E for the protection of consumers. This makes prepaid card accounts very similar to checking accounts.
Expect the Center for Financial Services Innovations (“CFSI”) to push de-facto rules and principles for prepaid cards demanding FDIC and Reg E protection, to ensure that the whole industry is homogeneous.

These are hardly the premises for a “shadow” banking system: banks are at the heart of prepaid, and consumer protections will be de rigueur for any serious competitor in this space.

Full disclosure: my own company, Plastyc, manages prepaid card programs and has received funding from Core Innovation Capital, the investment partner of CFSI.

Posted by PPeyret | Report as abusive

E Pluribus Nemo

Mark Dow
Sep 19, 2011 17:19 UTC

By Mark Dow
The opinions expressed are his own.

While Felix is away, I will be posting off-and-on, as my day job permits. I hope to be able to put out at least a couple of posts more thoughtful than a market update, but let me at least start with an update for the time being.

The market had been hoping there would be some cohesion coming out of Europe in the wake of the Geithner meeting; but none materialized. The grands lignes of what could be a plan are there, but the political hurdles in Germany seem still too high.

One, as various surveys suggest, Germany, in the aggregate, supports the notion of an integrated Europe, but also strongly opposes dedicating more resources to it. Yes, this is an excellent example of cognitive dissonance, but it is where we are. Two, in a profound and visceral way, Germans want to defend the purity of the ECB’s single mission. For them, the ECB is the Bundesbank, in thinly-veiled drag. And Germans don’t seem to be in a compromising mood.

These views, unfortunately, are incompatible not only with a permanent fix, but also with basic crisis management. Market participants know this. Secretary Geithner knows this. The IMF knows this. And all parties (except, it seems, a good number of European policymakers) are very worried. This is much of what markets are responding to today.

Moreover, markets will likely remain under pressure until Germany finds a way to overcome the moralistic, rule-bound, penny-wise-pound-foolish policymaking that has characterized the approach so far. Concretely, they need to lead the EU into cutting losses. And, as immoral and unjust as it will no doubt seem when the moment comes, they will have to dedicate resources to the peripheral countries if they want to minimize the collateral damage to Germany and other core countries that will flow from Europe’s restructuring.

The other element driving the market this morning is the continued unwind of risk in emerging markets. There has been a significant outflow over the past two weeks from emerging markets local markets (local bonds and currency). This sector has probably received more inflows relative to the size of the asset class than any other over the past 2-3 years. If risk appetite doesn’t resume soon, the EM outflows will almost certainly intensify. Fundamentals won’t matter. Valuations won’t matter. Secular convergence (more on this in the coming weeks) won’t matter. Only flows and liquidity will.

There was some easing in the outflows late last week, as equity markets rallied and hope that the FOMC might try and shock the markets took hold. However, due in part to the article last night by the Wall Street Journal’s influential Jon Hilsenrath, today market participants are abandoning the hope of a deus-ex-machina Fed. In consequence, the unwinds are accelerating.

Here’s a graph of the DXY, 2006 through today, to give you a rough indication of how far things could go:

True, it could well be that the Fed is using Hilsenrath to dampen expectation so as to surprise the market come Wednesday. After all, Chairman Bernanke understands the centrality of psychology in all of this. But to me it seems the divisions within the FOMC are too great to bridge at this one meeting. My guess would be that the FOMC meeting tomorrow and Wednesday will be used to prepare the groundwork for more aggressive action at a later date. As for where we go on Wednesday, anything up to and including Operation Twist will most likely be taken as a disappointment by the market, result in another leg up in the dollar, and an accelerated unwind of emerging market local currency positions. Of course, in markets, unlike in economic punditry, it pays to never get too comfortable with your own views.

COMMENT

@Curmudgeon, thanks for your contribution.

Posted by Woltmann | Report as abusive

I strenuously disagree with UBS CEO Oswald Gruebel

Sep 19, 2011 16:57 UTC

This post was originally published at Kid Dynamite’s World.

There are a lot of people out there who deride Wall Street as a bunch of loose canons gambling with other people’s money. Others think that Wall Street traders are dangerous psychopaths, where any one maniacal gunslinger can take insane risks and blow up the global financial system. As I’ve written numerous times: in all of my experience, this has not been the case. Now, however, we have the CEO of a major investment bank basically confirming those views. UBS CEO Oswald Gruebel was quoted today, in the wake of his firm’s $ 2.3B loss in a “rogue trader” scandal:

Speaking for the first time since UBS revealed the loss, Gruebel told the Swiss weekly Der Sonntag that the loss couldn’t have been prevented.

“If someone acts with criminal energy, then you can’t do anything. That will always be the case in our business,” the former trader said in the interview published Sunday.

Uggh.. Mr. Gruebel – are you sure you want to go that route? Because if what you say is true – that investment banks are helpless to prevent such actions, then the public’s fears about those banks being serious hazards to the global financial system are true. Again, with the experience that I have had, I positively do not believe that such losses are unpreventable.

I don’t really want to talk anymore about rogue traders – either:

a) I am a complete idiot and only a fool like me could not be able to figure out how to fool everyone in the bank and rack up billions in losses or

b) There are multiple systems in place to make sure that things like this don’t happen, and the bank has to seriously screw up in order to not catch it.

I think the answer is “b,” but if there’s a rogue trader out there who wants to give me a detailed crash course in how easy this is, I’m still willing to listen.

Numerous commenters on my previous two blog posts mentioned how easy it would be to fool the risk management systems. This may be partially true (although not on the scale of tens of billions of dollars), but my point with the earlier posts was to illustrate that there is a lot more than risk management involved.

Anyway, UBS released another statement today, including the details:

The loss resulted from unauthorized speculative trading in various S&P 500, DAX, and EuroStoxx index futures over the last three months. The positions taken were within the normal business flow of a large global equity trading house as part of a properly hedged portfolio. However, the true magnitude of the risk exposure was distorted because the positions had been offset in our systems with fictitious, forward-settling, cash ETF positions, allegedly executed by the trader. These fictitious trades concealed the fact that the index futures trades violated UBS’s risk limits.

Again, for me, this explanation isn’t a case of “oh ok – fine – now I completely understand how such a problem arose and went undetected.” My questions remain unanswered – how does no one say anything in Treasury – asking to confirm the notional amounts? How does no one confirm the details of the trades with the alleged counterparties? How does no one ask for margin as the losses accrue into the hundreds of millions and then billions of dollars? And finally, wtf is a “forward settling cash ETF position*?” Forward settling cash position is an oxymoron, isn’t it?

Most importantly, the reason I think it’s important to highlight why I disagree with Gruebel is because if Gruebel is correct, and Wall Street investment banks are helpless in the face of a bad apple trader who wants to reek havoc, then the entire Street should be shut down. Needless to say, I don’t think that’s the case, and I don’t think that the banks are helpless to detect criminal activity within their businesses. In fact, it’s one of their main jobs.

As SocGen “rogue trader” Jerome Kerviel said in a 2010 Der Spiegel interview:

SPIEGEL: Can banks really control people like you?

Kerviel: Of course. But you have to want to. Having more controls and regulations goes against efforts to pursue consistently higher profits at a time when all banks want to maximize their return on equity.

-KD

related: “I have an Error“ and “Losing $ 2B Without Anyone Knowing About it is Harder Than You Think

disclosure: My first job on Wall Street was as a summer intern at SBC Warburg, which later became Warburg Dillon Read and then UBS. I believe that I reported to a guy who reported to a guy who reported to a guy who reported to Oswald Gruebel, even back then. I have no positions in $UBS

* I think that what UBS meant by “forward settling cash ETF positions” is really “forward settling vanilla ETF positions” – ie, OTC forward trades in listed vanilla ETF products – as opposed to structured derivatives trades on ETFs or synthetic replication, etc… but that’s just my guess

Please make any comments on Kid Dynamite’s original post.

  •