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By: TFF Wed, 15 Feb 2012 13:36:08 +0000 “Mwwaters the claim commercial banks invest in safe boring assets would hold more water not for the fact they regularly fail.”

Danny_Black, the **assets** are too safe and boring to be of interest to anybody. So the commercial banks buy them up by the trillions and leverage them 97-3.

Pretty much any investment becomes exciting when leveraged 97-3. Just ask homeowners who bought at that leverage ratio in the bubble.

By: Danny_Black Wed, 15 Feb 2012 09:40:11 +0000 Mwwaters, you also miss the point that in a bubble people who do NOT take these crazy bets get killed. Phillip Purcell lost his job because he was trying to take MS out of the risky principal trading business. Perpetual Asset Management got taken over because it didn’t buy worthless internet stocks.

By: Danny_Black Wed, 15 Feb 2012 07:49:23 +0000 Mwwaters the claim commercial banks invest in safe boring assets would hold more water not for the fact they regularly fail. In the uk, it was “boring” lending that killed nrk, hbos, b&b. “boring” commercial real estate killed leh.

As for his contribution, pretty sure bsc paid more than a billion in taxes under his tenure which presumably goes to a “greater good”.

By: mwwaters Wed, 15 Feb 2012 07:24:43 +0000 Danny_Black,

There’s another way to look at Cayne’s losses: the fact that he had a billion to lose in the first place. As I argue above, whether he believed in Bear Stearns and personally invested a billion dollars is almost beside the point. By any way you look at it, he earned far more than he contributed to society.

It appears the only reason he earned so much is that Bear Stearns could buy assets earning slightly more than LIBOR while borrowing the money at LIBOR or less. The yield difference wasn’t much, but since short-term Bear Stearns debt was considered risk-free and earned more than T-bills, Jimmy Cayne could siphon off a few basis points off an imaginary spread and get a billion dollars of net worth in the process.

If the repo and commercial paper markets where Bear borrowed at LIBOR were instead treated as what they were, banking demand deposits for the big players of the financial industry, Cayne wouldn’t have earned such a nice spread. He would have had less leverage and the assets would have been limited to relatively predictable, safe, boring assets like FDIC-insured commercial banks are limited to. The big financial industry players are theoretically consenting adults who don’t need FDIC insurance, but their end investors generally aren’t very sophisticated investors who can suffer just as much as a depositor in 1929 if the repo and commercial paper markets suddenly suffer a run.

By: mwwaters Wed, 15 Feb 2012 07:09:41 +0000 Thanks for the comments loudnotes. My argument does assume that agents are completely rational and they cynically extract the maximum utility from principals under whatever incentive structure the principals give the agents.

The reality is a lot more complex. The partners of LTCM, Bear Stearns and Lehman all had much of their personal wealth in the equity of their companies. The LTCM partners even levered their personal investment to the point where many would have gone personally bankrupt if they weren’t bailed out.

In these cases, partners still tend to use their money to negatively skewed payoffs. They just don’t really know that they’re investing in negatively skewed payoffs. If there’s a long enough era of stability, then investors might stop considering certain possibilities and unknowingly attach themselves to negative skewness.

Furthermore, the agents who are true believers will win out against the completely cynical agents for capital. Outright deception is very tough. Goldman Sachs and other sell-side bond salesmen may not have an issue, but they sold their bonds to the true believers on the buy-side. The true believers were then the ones who really got capital from normal investors.

Also as Macro Resilience discusses, Principal-Agent problems didn’t just exist between investors and executives at money management firms. They also existed between executives and the middle-layers where the nitty-gritty trading decisions were made. As the e-mails that came out in the GS case and other cases showed, the traders could be far more cynical than those who faced investors. Traders (and risk managers) faced a choice between selling negatively skewed trading positions which could blow up or losing their job. These traders had far less of their personal wealth tied directly to their positions.

To get back to PIMCO and asset management fees, whether or not the agents are cynical or true believers doesn’t change the fact that agents can be compensated extremely well for negatively skewed bets. They may then lose that compensation if they personally invest in their positions, but nevertheless their compensation exceeds the value they create for society, which should be very worrying from a economic/regulatory perspective.

That’s also where moral hazard and government bailouts become worrisome. As TBTF banks and SIFI’s have more of an ironclad government guarantee, the financial system as a whole will maximize their returns by putting as much tail risk as possible on TBTF firms. We have no idea which asset will look fine until it crashes and burns, but we do know the TBTF structure creates an ideal scenario for negative skewness and that a large portion of the negative skewness will go to a handful of financial intermediaries up until the tail event happens.

By: Danny_Black Wed, 15 Feb 2012 03:33:32 +0000 Steve, not sure where u got 65bn but according to the latest cbo estimate, the tarp assistance to banks comes to a cost of 1bn, or put another way around the amount Jimmy cayne lost: 1/12-16-TARP_report.pdf

For the purchase of troubled assets, it either cost nothing or made the taxpayer 2bn. I assume the amount u got was for the whole of tarp including the 44bn planned giveaway to homeowners. Difference between the lowest rate for **collateralised**loans to banks frim the fed vs unsecured libor highest rate, assuming the maximum amount borrowed was constant fir the whole crisis was 400mn, or less than what dick fuld lost.

Frannie is where most of the taxpayer money has been used to socialise losses but then frannie were DESIGNED that way.

As for the other “costs” you are claiming, i assume u are planning to net them from the equallt vague gains in the bubble era

By: y2kurtus Wed, 15 Feb 2012 03:09:17 +0000 @SteveHamlin,

There are approximatly 7500 banks in the U.S. Fannie and Freddie are not among them. TARP was ballpark 700 billion. Most has been paid back with interest. Most of the rest will be paid back with interest. Their will be several billion that will not be paid back… but the interest on what did get paid back will more than cover the losses. By any reasonable measure the federal goverment will have made money on the financial bailout. Auto bailout didn’t go quite as well financially but hey Clint Eastwood and Detroit both seem apprecitive.

All banks good and bad large and small depend on the goverment during times of crisis. If you want to limit the risks they can take then it makes sence. As a banker I’m greatful for the goverment support… but so far that support hasen’t cost the taxpayers a dime that I can see.

By: SteveHamlin Tue, 14 Feb 2012 22:21:37 +0000 @Danny_Black: “What losses did the banks socialize in the U.S.?” Really? You’re being obtuse on purpose.

I’m assuming for this post that you agree that most large banks would not have survived 2008-2009 absent massive governmental intervention.

That assistance was directly to the benefit of bank shareholders and bondholders.

That assistance had, and is having, a cost: overpaying for bank assets by Treasury (subsidy/bailout – CBO estimates $65bn), risk borne by the government for free (Citi guarantee, JPM BS acquisition backstop guarantee, less-than-market haircuts on repo funding), a large chuck of Frannie’s losses are an ongoing bailout of mortgage originators/big banks. Ongoing financial repression, necessary intervention causing market distortions, abuse of the rule of law, a still-fragile financial system, and diminished trust in financial institutions – those are all real costs borne by the American public.

Most of the current enterprise value of large bank holding companies rightfully belongs to the taxpayer that rescued those entities from implosion. That the bailout cost was not booked on a GAAP basis, or that the administration has cooperated with this ongoing bailout, does not make it less costly to society, or less egregious.