News How Can We Truly Level the Playing Field?

[WhoWee]

You are harping on now for pages about one word - "hick". The original point was my objecting to your characterisation of the financial sector as "highly regulated". I argued that the credit crunch was caused by the explosive rise of an opaque, off-balance sheet, market for structured financial products and the consequent emergence of predatory behaviour.

Regulation is needed to create transparency and level playing fields in markets so that even ordinary folk can safely invest. But the derivatives casino created an environment in which even "sophisticated" banks, with newly created trading desks, became easy marks. As IKB showed.

You don't actually seem to disagree with anything substantive about what I've just said. You have agreed about the casino aspect, the predatory aspect, the regulation aspect.

You are now repeating points I originally made as if these were novel thoughts...


So you can see why your comments seem like trolling rather than a serious intent to engage with the meat of my arguments.

If you actually have some substantive disagreement with my views about the demonstrated perils of unregulated, geared trading, then start a proper thread about it. But so far, it has been nitpicking to little effect because you don't fundamentally disagree it turns out. All IMO

Just to clarify, I've never argued against the regulation of derivatives trading - just the coordination of implementation at some future point in time. However, I often argue that the financial sector is highly regulated in areas other than derivatives.

As for the idea that anyone actively trading in derivative markets is unsophisticated - I just don't subscribe. With a quick look at this link for some standardized documentation from the industry - the complexity of the market is obvious.

http://www.isda.org/c_and_a/equity_der.html

 

[apeiron]

As for the idea that anyone actively trading in derivative markets is unsophisticated - I just don't subscribe.

Okey dokey. And the other view to which many subscribe is that the definition of "sophisticated" is one of the key issues to be considered post-crunch.

And this other view has been acted upon (which rather undermines your claims here)...for example...

Julian Le Fanu, a policy adviser to the UK’s National Association of Pensions Funds (NAPF), says while the report might tackle the lack of boundaries to protect investors in the US investment market, the UK’s Financial Services Authority already places a requirement on any investment provider to ensure an investor is capable of understanding the risks of the product it invests in, as has the recent introduction of the EC’s Markets in Financial Instruments Directive (MiFID).

“We have been through a round of investor reclassification, particularly through MiFID, with new boundaries in client classifications, so financial institutions’ classifications have been reviewed to ensure they are in line with the requirements of the MiFID,” said Le Fanu,

http://www.ipe.com/magazine/are-pension-funds-sophisticated-enough_29196.php

 

[WhoWee]

Okey dokey. And the other view to which many subscribe is that the definition of "sophisticated" is one of the key issues to be considered post-crunch.

And this other view has been acted upon (which rather undermines your claims here)...for example...

I get it - but there's a big difference between investors and traders.

 

[apeiron]

I get it - but there's a big difference between investors and traders.

But "sophisticated investor" is the actual issue here isn't it? It is the term recognised in financial regulation. And the term being used in defense by GS, Deutsche, et al. Why are you trying to misdirect to "trader" when that was not what was under discussion?

 

[WhoWee]

But "sophisticated investor" is the actual issue here isn't it? It is the term recognised in financial regulation. And the term being used in defense by GS, Deutsche, et al. Why are you trying to misdirect to "trader" when that was not what was under discussion?

Isn't the argument related to IKB their specified trader status? It was the intent of IKB to make a market in derivatives - wasn't it?

 

[apeiron]

Isn't the argument related to IKB their specified trader status? It was the intent of IKB to make a market in derivatives - wasn't it?

Do you still not realize that "sophisticated investor" is a technical term here? Or are you chosing to ignore that? Which would be intentional misdirection of course.

IKB was not the originator but the purchaser of the CDOs. So you may want to call them "actually a trader". But the defence being used by the likes of GS (the originators) against the suckers (purchasers) like IKB, and the many other fools, is that they can be classed technically as "sophisticated investors" and so have to look out for themselves.

In case you really don't know the distinction, to save you making the same mistake again...

Securities and Exchange Commission Rule 501-D lists the classes of people and institutions that are "accredited" or sophisticated investors, meaning they are exempt from the protections afforded the so-called small investor. They include banks, insurance companies, business development companies, charitable organizations, nonprofits and so on.

http://www.forbes.com/2009/03/24/ac...ance-financial-advisor-network-net-worth.html

 

[WhoWee]

Do you still not realize that "sophisticated investor" is a technical term here? Or are you chosing to ignore that? Which would be intentional misdirection of course.

IKB was not the originator but the purchaser of the CDOs. So you may want to call them "actually a trader". But the defence being used by the likes of GS (the originators) against the suckers (purchasers) like IKB, and the many other fools, is that they can be classed technically as "sophisticated investors" and so have to look out for themselves.

In case you really don't know the distinction, to save you making the same mistake again...

I understand the meaning of the term - no misdirection or mistake either - it's the correct analysis (IMO).

I'm trying to understand why you don't think IKB (a company with enough sophistication to serve as a trader in the derivatives industry) wasn't sophisticated or competent enough to be considered a "sophisticated investor" as per your posted description? Just because they are buying rather than selling doesn't change their stature at the table or in the market. Forget the word trader - they were experts in the industry by virtue of their level of participation - weren't they?

From their financial report: my bold
http://www.ikb.de/content/en/ir/financial_reports/annual_report_2010_2011/GJ2009_10_AG_en_final_sicher.pdf
"IKB’s strategic positioning
IKB Deutsche Industriebank AG (IKB AG or IKB when referring to the Group) has undergone
comprehensive restructuring in the past four years of severe global financial crisis. Key risks have been gradually reduced. Lending business without real customer relationships and very long-term project and export financing activities are no longer being actively continued. The Bank has been completely refocused on its traditional customer base – particularly German SMEs with sophisticated financing requirements.

Its business model has been expanded parallel to this. IKB no longer just offers its corporate clients (with sales upwards of € 50 million) credit financing, but an increasingly wider range of capital market and advisory services (such as derivatives, placements, M&A, restructuring advisory) that allow them to optimise their financing structure and grant them access to the capital market. In terms of acquisition
finance, IKB works closely with private equity companies. As new business shows (increase in new lending business at IKB AG including the Leasing Group in the 2010/11 financial year: from € 3.0 billion to € 3.7 billion), IKB is satisfying the requirements of its existing customers, some of whom have been with IKB for decades, with this new approach. "

This report also describes the steps taken to adjust the portfolio of derivatives.

Surprisingly, the report makes this projection.my bold
"The future earnings structure will feature a stronger share of commission income from consulting, derivatives and capital market business. With lower consolidated total assets on account of the EU requirements, net interest income will initially decline and later stabilise in the medium term as new lending business grows. The expenses of the guarantee commission owed to SoFFin will diminish."

The more I read through this report - the less convinced I am that IKB was a babe in the woods - just my opinion.

 

[apeiron]

Forget the word trader - they were experts in the industry by virtue of their level of participation - weren't they?

Hick bank tacks on trading desk to jump aboard the whizzy world of structured finance and it blows up in their faces big time. End of story IMO. The results speak for themselves.

Again, you seem to be citing sources without apparently understanding them. The current IKB report says quite clearly that it has dropped all that whizzy SIV stuff that it proved too unsophisticated to handle and has returned to the hick medium-scale corporate financing that was its bread and butter before a hotshot CEO came along and convinced people he knew what he was doing.

You seem to be confusing (intentionally misdirecting?) corporate finance instruments - derivatives, placements, M&A, restructuring advisory - with the SIVs concocted from junk CDOs. If you have a history in corporate finance, then it is at least plausible that there is expertise there. But this is all about traditional banks getting greedy and trying to cash in on markets like subprime that they had no track record in.

IKB AG set up a hands-off trading entity, IKB CAM, then sat back and waited for the cash to roll in. You may want to claim that IKB CAM were "black art" experts and no babes in the woods. And they certainly behaved as if they believed they were BSDs from Wall St. But history's judgement is that they got carved up by GS and Deutsche. And IKB AG was left sitting there, dazed in the middle of the road, saying, duh, what just happened?

Hear it from the horse's mouth...

GUNTHER BRAUNIG, CEO, IKB DEUTSCHE INDUSTRIEBANK AG: Good morning, ladies and gentlemen. When I was appointed at the end of July to master the crisis IKB was facing I set myself three targets; to create transparency, to stabilize the Bank, and to realign the Bank's business...

...IKB's Board of Managing Directors considers the following findings from the report to be key. First, the report criticizes the way in which essential tasks that transferred to IKB CAM, which was established as an asset manager by IKB in 2006. Key words here are organizational deficiencies, inadequate authority investment -- in investment decisions, and inadequate control mechanisms in particular.

http://goliath.ecnext.com/coms2/gi_0199-9747818/IKB-Deutsche-Industriebank-AG-Special.html

 

[LaurieAG]

Hear it from the horse's mouth...

It reads like it came from the horses other end though.

According to the PwC report, the audit reports that were presented to the Supervisory Board did not include any indications of the existence of subprime risk for IKB either. This applied, in particular, to a special audit concerning risk and interest management which was commissioned by our Supervisory Board and carried out by an independent accounting firm. Hence, the Supervisory Board was unable to recognize the special risk situation that led to the IKB's existential crisis. The PwC report concludes that the Board of Managing Directors did not inform the supervisory board adequately about the overall economic picture. Overall, we as the Board of Managing Directors agree with the risk assessment by PwC.

 

[WhoWee]

Hick bank tacks on trading desk to jump aboard the whizzy world of structured finance and it blows up in their faces big time. End of story IMO. The results speak for themselves.

As much fun as this is - we just don't agree. IKB took a seat at the big table and hired an expert to sit in the seat. If they had been able to dump their holdings onto someone else - they would have been hailed as winners and experts.

Now, after they've taken losses - nobody owes them anything. The playing field was even when they sat down. The big Wall Street banks weren't required to measure the skill set of their trading partner before executing a trade.

By comparison, if you owned a commercial property and leased it to a used car lot for 20 years and on occasion loaned the operator money to buy inventory - made a nice return. You might consider yourself an expert at leasing that piece of property and loaning working capital to flip cars.

Now, if that owner retires and you decide to hire someone away from another dealership to manage the lot and buy cars with your money - you stand to make more money in the deal. It is your responsibility as the owner to make a good hiring decision and to fund the deal properly - the operation of the business is then left to your hired help.

If that experienced car guy you hired takes your life savings to the auto auction and buys 100 cars that are inoperable for a variety of reasons and causes you to lose half your money - who should you blame? The playing field was level at the auction - nobody made your man buy the cars. He thought he made good deals - but in reality he bought cars that nobody else wanted.

Were you or your man duped? He thought he was getting a good deal - and if additional investment wasn't required to repair the cars - it might have been a good deal.

At the end of the day, there's only one way to become an expert in a field - you have to engage in activities and learn from your mistakes. I love old sayings - if you can't take the heat, then stay out of the kitchen.

IKB had the resources to participate and accepted risk with the intent of leveraging large profits - they failed. Nobody owes them anything - IMO.

 

[John Creighto]

With regards to European banks and subprime loans, I’m not sure which banks would have had access to the reports which showed how the (loan quality statistics)/audits were messaged to look better than they were. As a general rule of thumb though banks only have to take a 50% risk weighting on mortgages assets when calculating their capital adequacy. There is nothing in these calculations which measure the ability of the borrower (or population in general) to pay. When times are good the higher a bank can leverage and the more profit they make. When times go bad, the CEOs already made their bonuses.

Anyway, aren’t we way off topic?

 

[MarcoD]

IKB had the resources to participate and accepted risk with the intent of leveraging large profits - they failed. Nobody owes them anything - IMO.

It's a difference between European and US trading I think. In northern Europe, when customers find out they bought a bad (financial) product, it is not unusual that the selling party, partly or wholly, compensates the customer. I gather this is different in the US.

(Not that European dealers are angels in that respect. Everybody tries to buy insurances on burning houses. It's just that in short term it is always good for a good laugh, but on the long run it's bad for business. And I guess Germans sometimes lack a sense of humor.)

 

[apeiron]

If they had been able to dump their holdings onto someone else - they would have been hailed as winners and experts.

If, if, if.

But the discussion is not about hypotheticals but about facts. And the one you keep disputing is the commonplace statement that many of the banks and other institutions brought down by derivatives lacked the competence to assess the risks of these opaque products.

The story is of sleepy, highly regulated institutions who suddenly changed their business models when derivatives/banking were deregulated and entered the game - the level playing fields - without the internal governance systems or institutional expertise to deal with the risks they were exposing themselves (and their customers) to.

Now you offer cute annecdotes about car yards. We are talking about banks where hiring a few traders is not good enough. There has to be a whole culture for a bank to be an "expert".

You mentioned earlier the S&L saga in the US. Perhaps, like Marco says, you just lack familiarity with how similar the parallels are regarding European banking and structured finance in the mid-2000s.

But it has been much written about. For example, LSE's Robert Ward on the Icelandic banks...

There is no mystery about how it happened. The publicly owned,
locally oriented, “savings and loan” type banks were quickly privatized
in the late 1990s and early 2000s, sold to owners friendly to the ruling
political parties, deregulated, and set loose. They quickly transformed
themselves from “utilities” doing retail banking to “utilities attached
to casinos”...

...This is how the banks became an accident waiting to happen. They
were in a position similar to that of the savings and loan banks in the
United States in the late 1980s, which were hastily deregulated, leaving
their inexperienced managers free to play in the big leagues, with
little regulatory restraint. The result was the “savings and loan” crisis,
which cost several percentage points of U.S. GDP to put right.

http://www.challengemagazine.com/extra/005_033.pdf

Or the Economist on Germany's landesbanks...

it sold sophisticated financial structures, including investments in American subprime mortgages, to IKB, a small German lender, and was the first to pull the plug, six weeks ago, when IKB got into trouble. Josef Ackermann, Deutsche Bank's boss, has little time for such criticism. He blamed some German banks for taking on risks beyond their capacity and competence...

...Landesbanks were set up to act as wholesale financiers alongside state-owned regional savings banks. With a state guarantee they were able to fund themselves cheaply, making their lending profitable. When their state guarantee was abolished in 2005, under pressure from Brussels, they found it harder to obtain cheap new funding and had to scour for higher-yielding assets. Investment banks touting mortgage-backed securities from America found a particularly receptive audience at SachsenLB. Other banks were also tempted into rough waters...

http://www.economist.com/node/9769382

A Forbes comment at the time...

The talent pool of employees at the Landesbanks are not near the caliber of those who work for the bigger, private-sector institutions like Deutsche Bank. "Some of these banks are simply out of their depth when dealing with these transactions and they didn't have sufficient management system in place to control what was going on," said Kline.

http://www.forbes.com/2007/08/21/ge...prime-markets-equity-cx_po_0821markets20.html

The reason all this matters is that without the steady flow of suckers, there couldn't have been the crisis. Goldman Sachs and the other big city sharks needed someone fresh off the bus to buy their shonky wares.

You can keep protesting that these hick, inexperienced, unready financial institutions were technically "expert" and it was quite legal to relieve them of their small town innocence as part of their rapid and necessary life education having arrived in the big smoke.

But I'm not sure how that squares with you also feeling that the derivatives world is much in need of regulation to protect these same "expert traders".

 

[MarcoD]

You can keep protesting that these hick, inexperienced, unready financial institutions were technically "expert" and it was quite legal to relieve them of their small town innocence as part of their rapid and necessary life education having arrived in the big smoke.

Personally, I don't think we'll ever know what the real story is. I mean, say Deutsche Bank wants to invest in risky stuff but can't be bothered to take on the risk. Of course, a manner out of that is starting a separate business, take stock in that, let it be filled with capital, and let them do the risky investments. That manner, you get all the profits with only a low risk. How do we know IKB is not a financial vehicle of Deutsche Bank?

I have the feeling that there were loads of these small companies, and all the public does is just mutter about the fact that cheap money created lots of bubbles and these bubbles blew up.

Bloomberg reported 200.000 laid off in the financial sector. Probably there is nothing left to regulate since nobody, except for the public, will be stupid enough to invest in business dealing in CDSs or CDOs for a decade or two. (I don't have money, but I know I wouldn't. Looks to me that the easiest manner to be ripped off is to invest in complex portfolio's or financial products.)

(Sorry for changing my opinion, but after looking at some Bloomberg and reading some, I have the feeling that nobody knows anything, especially not the media. I mean, I got the feeling that every banker's statement should be read as a poker bet. "Stuff is going lousy" = "I found an exceptional market, am making loads of money, no need to get involved" and "The bank is doing fine" = "Were almost broke and can't use a bank run.")

 

[WhoWee]

If, if, if.

But the discussion is not about hypotheticals but about facts. And the one you keep disputing is the commonplace statement that many of the banks and other institutions brought down by derivatives lacked the competence to assess the risks of these opaque products.

The story is of sleepy, highly regulated institutions who suddenly changed their business models when derivatives/banking were deregulated and entered the game - the level playing fields - without the internal governance systems or institutional expertise to deal with the risks they were exposing themselves (and their customers) to.

Now you offer cute annecdotes about car yards. We are talking about banks where hiring a few traders is not good enough. There has to be a whole culture for a bank to be an "expert".

You mentioned earlier the S&L saga in the US. Perhaps, like Marco says, you just lack familiarity with how similar the parallels are regarding European banking and structured finance in the mid-2000s.

But it has been much written about. For example, LSE's Robert Ward on the Icelandic banks...

Or the Economist on Germany's landesbanks...

A Forbes comment at the time...

The reason all this matters is that without the steady flow of suckers, there couldn't have been the crisis. Goldman Sachs and the other big city sharks needed someone fresh off the bus to buy their shonky wares.

You can keep protesting that these hick, inexperienced, unready financial institutions were technically "expert" and it was quite legal to relieve them of their small town innocence as part of their rapid and necessary life education having arrived in the big smoke.

But I'm not sure how that squares with you also feeling that the derivatives world is much in need of regulation to protect these same "expert traders".

Your point is noted - I'm just not as convinced as you are that the biggest sharks are in NY, nor that IKB was a lamb.

On a side note - perhaps the European bankers should have read "Liar's Poker" - since Congress (apparently) didn't.

You'll enjoy this interview with Lewis Ranieri on CNBC.
http://video.cnbc.com/gallery/?video=3000006596

 

[apeiron]

Personally, I don't think we'll ever know what the real story is.

The details are still being uncovered, but people actually do know the story very well. And in some cases, they knew ahead of the event, as these very fine Economist articles reveal.

But as I said about Atlantic Computers, you can tell people exactly what is going on, however when their eyes are alight with dollar signs, you can see they are not listening. Or they know, but believe they can be in and out of the market before it collapses around their ears.

So on Deutsche Bank, the Economist had this penetrating analysis in 2004.

Mr Ackermann and his ten-man group executive committee have taken Deutsche in precisely the opposite direction. Since 1996, they have been transforming it from a giant institution serving German commerce to a global money machine with no particular national loyalty. The bank has given up on its ambition to become a financial supermarket like the mighty Citigroup. Now it increasingly models itself on Goldman Sachs—which does not shirk from taking risk—to the detriment of its other existing and potential businesses. According to one joke circulating in Frankfurt, the German financial centre where the bank is based, Deutsche is actually run by an Indian “bond junkie”: Anshu Jain, its head of markets.

Mr Ackermann and his team have other priorities than messy domestic mergers. They want to create a global institution with a 25% return on equity.

http://www.economist.com/node/3128013

I mean, a 25% return??

Then this 2000(!) article from the Economist right at the start of the derivative bubble, which seems incredibly prescient (except of course for those who had seen the dotcom boom, hedge fund blow ups, S&Ls, etc, etc)...

Mr Gibbons, for one, is unconvinced. In particular, he worries about American banks' phenomenal profitability. Over the past four years, banks in America have made, on average, a return on equity of 16.5%. In international terms, that is a stunning result. How have they managed it? By taking ever more risk, thinks Mr Gibbons. And for that, thank some of the recent changes in financial markets.

The first is deregulation. In many ways, this has been a good thing. Since 1994, banks have been free to spread their wings across state borders, making them less susceptible to problems in anyone region. Thanks to a loosening of the division between commercial and investment banking dictated by the Glass-Steagall act, commercial banks have also been able to get into the investment-banking business. J.P. Morgan almost reinvented itself as an investment bank (though not, it transpires, a particularly successful one: it has just been swallowed up by Chase Manhattan, a bigger bank that also has investment-banking pretensions).

But there is a downside to deregulation. It has been behind just about every banking crisis of recent times. Banks have opened their coffers and lent as if there were no tomorrow, either simply because they were able to do so, or because they felt they had to stop new entrants to the market eating into their business, or both.

http://www.economist.com/node/404464

 

[MarcoD]

Silly remark gone.