As for AAA bonds, you are correct. **HOWEVER** investment professionals seem to get the two confused sometimes. Doesn’t matter if the bonds pay out if you fail from a lack of liquidity (triggered by MTM losses).

dsquared, to be fair in my initial response I did misunderstand why you thought 0.17 credit losses was not a valid measure for AAA as opposed to mtm losses. I have heard over and over again that that AAA are “ultra-safe” and you “can’t lose money” when in fact it is merely a statement on how likely the issuer is to make the promised coupon and principal payments on time.

The issue for most people is whether such salaries are justifiable, in the interests of shareholders, markets, or economies, or even necessary as a means of recruitment.

Of course, those who receive the salaries will always try to justify them, while headhunters (paid again by proportion of salary achieved) will always say they are necessary. Remuneration committees will always say they are worthwhile for the company because executives sit on each others’ remuneration committees. Shareholders – in the form of institutions – will not say it is not in the interests of the company because they always vote with the management and sit on each others’ remuneration committees, or are paid a commission bonus basis for the running of their funds and would hardly vote against the system that keeps them feeding from the same trough.

As for the politicians, they vote with their backers, and their backers are very often rich bankers – this is certainly true of the UK Conservative Party. Any political system that depends on high spending to be elected will be susceptible to the influence of those with the biggest pockets.

If you are saying “not fine” in the sense of short-term mtm losses then a) AAA corporates in later part of 2008 also suffered large peak to trough losses b) the email was written in feb 2007 and for the next 4 months he would have been absolutely right. Also LEH was one of the first to cut back on sub-prime when it first started declining in mid-2007.

I am also pretty sure I can find a 18 month period in which japanese government bonds differ peak to trough by 20% too.

If you are saying “not fine” in the sense of expected credit losses at maturity, then the proper comparison is AA corporates because in 2007 they were trading at roughly the same spread and AA corporate credit over that same time period is around 1%.

LEH went bankrupt because of its holdings of AAA subprime-RMBS? It took huge losses on AAA sub-prime RMBS? Because that is most definitely NOT what the bankruptcy examiner found:

“Lehman’s management also successfully hedged its subprime mortgage risk, at least until early 2008, and avoided some of the catastrophic investments that other financial institutions made in the mortgage market, for example in CDOs.”

“In general, your usual approach of combining bluster and other people’s talking points and trying to pass it off as expertise isn’t going to work this time” – weird because this is exactly what you do. You make claims that GS couldn’t repo CDOs in Oct/nov 2008 when it clearly could through TSLF. You made claims that libor-OIS spread was not coming down in end Oct/ beg nov 2008 when it clearly was. You are claiming here that LEH took huge losses on AAA subprime when it didn’t and implying that it had something to with LEH bankruptcy when if the rest of their investments had performed as well they would still be here.

Let me guess… equities right?

I was trying to be charitable and assume that you were merely confused rather than intentionally injecting a misleading statistic. If someone is head of rates *trading* (I do not see any “Head Of Holding Bonds To Maturity” on that list), at an institution with more than 20x leverage and a very high proportion of short term funding, then if they say a bond is going to be “fine”, they had better mean “fine”, not “potentially fine if you can wait twenty years”. The guy didn’t say “potentially only seeing three times the loss on other AAA securities in the long run, but we’d better sell it now”. He said “fine”.

And you’re ignoring the fact that the default rate so far, even on AAA tranches, has been significantly higher than similarly rated corporate securities. AAA aren’t meant to have any losses at all; they ought to be safer than, say, Japanese government bonds. So even from a hold-to-maturity credit investor’s perspective, they weren’t “fine”.

In general, your usual approach of combining bluster and other people’s talking points and trying to pass it off as expertise isn’t going to work this time. Very few people are likely to fail to notice that Lehman Brothers went bankrupty, or that it had huge losses on holdings of AAA rated subprime RMBS, so you have an uphill struggle in trying to establish that “the AAA tranches will be fine” was a really brilliant thing to say.

Both arguments are probably false. I work in software, a field where owners of the company are largely paid in relation to an increasing stock price (or valuation), something that has been lacking in the financial industries for quite a while. The “best” non-owner employees (however you might define best) are largely paid a good salary with some bonus/stock component that can add somewhat less than a multiple of that salary. Perhaps 2-3 exceptional sales people earn more in commission than a single multiple of salary. I think this model is probably more normal across industries.

The banking companies (however you might define that) seems pretty unique as a model where employees (sales and at least some non-sales) expect a percentage of revenue seemingly generated (or profit, although that is a tricky thing to calculate at an individual level) as their due. I think this, more than anything, is what tends to annoy people. Ultimately, I think this will be the downfall of banking/finance.

That doesn’t mean, however, that there aren’t legitimate areas of concern related to topic at hand that might be addressed. I’ll throw out a few:

1. Unfettered, Opaque Derivatives Trading: We have plenty of evidence at this point that the system as structured is pretty much begging people to make very large bets on behalf of their institutions, with very little downside to them. They walk away with a large reward if it goes, or can be made to appear to go, right for long enough, and they see little penalty if it goes wrong while the system as a whole bears the brunt. We’ve incentivized people to insert huge risks into the system, and we shouldn’t be surprised that many are ready to respond to that incentive.

2. Conflicted Credit Rating Agencies: I’ll grant that there is *some* information provided by these agencies, but the mere fact that they are paid by those wishing to be rated is the proverbial elephant in the room that no one discusses. As above, we have recent ample evidence that they are totally unable to provide meaningful information in the presence of systemic risk, not to mention the myriad of other ways they can be hoodwinked, pressured (direct and indirect) and/or manipulated.

3. High-Frequency Trading: The primary purpose of securities exchanges is to provide liquidity and information through price discovery. HF traders provide essentially nothing to the latter, replace a steady flow of liquidity with a raging torrent in calmer times, dry up along with other sources in a panic, and in general impose a tax on those wishing to use the exchanges for its more mundane and useful purposes. So, in return for increased volatility, the rest of us get…well, we get to pay for it.

The common thread here is that some relatively straightforward changes to regulations could make significant improvements to these areas, to the benefit of everyone but a few ridiculously-well-compensated individuals. Those individuals would *still* be well compensated, perhaps just a little less so, and the rest of us would be living with a much lower state of risk. And frankly, until at least items 1 and 2 are changed significantly, we’re going to be living with a lot of risk.

The managers of these people though are mostly from a select group of people who went through the right schools, had the right family backgrounds, and only rarely come through from the bottom up. There are many more people that have the same skill sets that could do the same job of managing traders but they choose to apply for jobs in Nottingham, Manchester and Liverpool.

It’s even arguable, as Nassim Nicholas Taleb does in his book “Fooled by Randomness; The Hidden Role of Chance in Life and in the Markets” (the Black Swan book) that the success of these people in their jobs owes far more to luck than judgement; let’s face it, anyone can make a profit in a rising market, the successes are those who can survive through a downturn.

As for your claims about the other tranches being wiped out that is simply untrue. total losses on investment grade subprime RMBS to middle of last year were less than 6%. AA was around 18%, A 40% and BBB less than 60% – quoting from recollection on a post i read.

There are still millions of delinquent homes, and millions of additional foreclosures to happen. All to eat the AAA rmbses.

http://andolfatto.blogspot.com/2011/08/b ad-rap-for-bond-raters.html

If there were such small losses to be had, then there’d be tons of money to be had by buying the mbs at near par prices. Are people doing this?

One can complain about how much middle and lower tier people at banks were paid but at Hoffman’s level he is probably fair value.

It is a very competitive environment, with evaluations that are far more objective/quantitative than most employment. Networking is critical in the hiring process, but after that people rise according to their various competence (and willingness to take big risks with other people’s money).