Posts filed under “Derivatives”
Satyajit Das is author of Traders, Guns and Money (2006) and Extreme Money: Masters of the Universe and the Cult of Risk (2102)
It would be ironic if Cyprus, one the smallest countries in Europe with little over 1 million people and about 0.5% of the European Union (“EU”) economically, were to prove a key inflexion point in the crisis.
Since June 2012, it has been known that Cyprus needs around Euro 17-18 billion to recapitalise its banks (around Euro 10 billion) and for general government operations including debt servicing (around Euro 7-8 billion). While small in nominal terms and well within EU’s resources, the amount is large relative to Cyprus’ Gross Domestic Product (“GDP”) of Euro 18 billion. It is unlikely that Cyprus can realistically repay it, in the absence of a dramatic change in its circumstances such as the mooted oil and gas reserves in the Eastern Mediterranean.
The various options considered to generate the required funding included: privatisation of state assets, increases in corporate taxes (from 10% to 12.5%) and withholding taxes on capital income (to 28%) and restructuring of existing bank or sovereign debt. Debt restructuring options included a “bail-in” of creditors (the new fashionable term for a write off of principal). It would also entail easing terms and lengthening maturities of (up to) Euro 30 billion in loans from Russian banks to Cypriot companies of Russian origin.
The package proposed by the EU incorporates almost all of the above measures. Most controversially, ordinary depositors will face a “tax” on Cypriot bank deposits, amounting to a permanent write down in the nominal value of their deposits. The deposit levy will be 6.75% on deposits of less than Euro 100,000 (the ceiling for European Union account insurance) and 9.9% for deposits above that amount. In return, the depositors will receive shares in the relevant banks.
The unprecedented write down of bank deposits expected to raise around Euro 5.8 billion is motivated by a number of factors.
Firstly, International Monetary Fund (“IMF”) participation requires the debt level to be sustainable. The write off of depositors reduces debt and also the size of the required bailout package to Cyprus to Euro 10 billion.
Secondly, Cypriot banks have limited amounts of subordinated or senior unsecured debt. This means that a write down of bondholders would only raise between Euro 1 and 2 billion, below the required amount.
Barry Ritholtz, CEO at Fusion IQ, and Tangent Capital Partners’ Bob Rice talk with Bloomberg Law’s Lee Pacchia about the current state of the derivatives market and a recent initiative by ISDA to write new standards for credit-default swaps.
(if Video does not load, click here)
Josh Rosner (
@JoshRosner) is co-author of the New York Times Bestseller “Reckless Endangerment” and Managing Director at independent research consultancy Graham Fisher & Co. He advises regulators, policy-makers and institutional investors on banking and financial services (a more complete bio appears at the end of this column).
This is part 4 of 5; Yesterday evening, we published the Introduction. We will be releasing a different part each evening and morning culminating in the release of Rosner’s complete report on Friday morning. On that date, the Senate Permanent Subcommittee on Investigations will release their final report on JPM’s CIO Group (aka the London Whale).
In the wake of at least $6.2 billion in losses and an earnings restatement in the CIO’s office, which manages JPM’s excess cash and should therefore be run by top talent, the regulatory response has been surprisingly muted. The two reports issued by JPM in early January were unrevealing and illustrate the current state of regulatory capture where large financial institutions are concerned.
When Freddie and Fannie suffered accounting scandals early last decade, with Freddie understating earnings and Fannie overstating them, the Companies’ and their regulator (OFHEO) recognized the importance of credible investigations. Freddie hired an outside firm to do an independent investigation[i] and their regulator embarked on two detailed and meaningful investigations.[ii] After these investigations were complete, OFHEO issued exhaustive and meaningful demands on the companies in the form of Consent Orders[iii].
On January 14, 2013, without the benefit of a similarly complete investigation, the Federal Reserve issued two fairly narrow Consent Orders to JPMorgan.[iv] The first order related to violations of the Bank Secrecy Act and anti-money laundering requirements, the second to the losses in the Chief Investment Office. Neither of these orders appears to have resulted from any meaningful investigation and neither addressed the many other recent failures of the Company’s internal controls. When the rod is spared, as seems to be the standard approach to dealing with violations by our biggest banks, we find ourselves reminded that spoiled children behave badly.
The ability of any management team to steer a company with a balance sheet as large as JPM’s seems an impossible feat, one that bears inquiry and consideration. While the “London whale” losses are generally viewed in isolation they are little more than the most dramatic recent example of poor internal controls.
A Whale’s Tale – a Whitewash Report
When compared to the report the Board of Freddie Mac undertook, JPM’s “Task Force” was a whitewash. Freddie initiated a truly independent investigation by an unaffiliated firm and directed all employees of the Company to fully cooperate with the investigation. There were no limitations proscribed on the scope of the review and as the investigators or the Firm’s independent auditors discovered additional matters they were also looked into[v].
In contrast, JPMorgan’s “Task Force” issued a report of questionable independence and limited in scope. Michael Cavanagh, co-Chairman of JPMorgan’s investment bank, led the “Task Force”. Cavanagh reports directly to Jamie Dimon and is both a longtime “lieutenant” and his possible successor[vi].
For Michael Cavanagh to be tasked with investigating another executive that reported directly to Jamie Dimon[vii] about losses in a unit that he knew, as early as 2010, appeared to have inadequate controls[viii] is more troubling. As former SEC Chairman Harvey Pitt said, “It’s incomprehensible to me that they did these reports internally, it’s like asking Joe Paterno to do the Penn State [sexual abuse] investigation instead of [former FBI director] Louis Freeh… having picked Cavanagh to do this strikes me as potentially foolish in the extreme, the only reason you do a review this way is because you don’t want to find anything unduly damaging[ix].”
The Task Force Report
While we will offer some assessments of the primary content of the report it is important to recognize that, as is often the case, some of the most valuable information is buried in the footnotes. As a result, we will first focus on many of those items.
- Footnote 2: The description of “what happened” is not a technical analysis of the Synthetic Credit Portfolio or the price movements in the instruments held in the Synthetic Credit Portfolio. Instead, it focuses on the trading decision-making process and actions taken (or not taken) by various JPMorgan personnel. The description of activities described in this Report (including the trading strategies) is based in significant measure on the recollections of the traders (and in particular the trader who had day-to-day responsibility for the Synthetic Credit Portfolio and was the primary architect of the trades in question) and others. The Task Force has not been able to independently verify all of these recollections.
This footnote raises questions about the thoroughness of the investigation.
- Footnote 10: John Hogan, who succeeded Mr. Zubrow as the Firm’s Chief Risk Officer in January 2012, did not have sufficient time to ensure that the CIO Risk organization was operating, as it should. Nevertheless, the Task Force notes that there were opportunities during the first and second quarters of 2012 when further inquiry might have uncovered issues earlier.
While it may in fact be true that John Hogan did not have sufficient time to address the control problems in the CIO’s office, the reality remains that problems in risk management of the CIO’s office existed, and were known to the firm’s most senior management[x] possibly for several years prior to the 2012 trading losses. This reality calls into question the accuracy of the firm’s filings[xi] and compliance with Title III of the Sarbanes-Oxley Act[xii]. Investors may well wonder whether, as long as those weak controls were generating outsized profits; management was not interested in correcting those control weaknesses.
- Footnote 20: Although the Task Force has reviewed certain general background information on the origin of the Synthetic Credit Portfolio and its development over time, the Task Force’s focus was on the events at the end of 2011 and the first several months of 2012 when the losses occurred.
Did Securitization Lead to Riskier Corporate Lending? João Santos February 04, 2013 There’s ample evidence that securitization led mortgage lenders to take more risk, thereby contributing to a large increase in mortgage delinquencies during the financial crisis. In this post, I discuss evidence from a recent research study I undertook with Vitaly Bord…Read More
Is it possible that the Credit analysts who rated subprime junk as AAA at S&P are even more odious, more corrupt, more execrable than I previously imagined?
As this email from the government’s complaint (via Dealbook) shows us, yes!
[S&P analyst]: With apologies to David Byrne…here’s my version of “Burning Down the House“.
Housing market went softer
Strong market is now much weaker
Subprime is boi-ling o-ver
Bringing down the house
CDO biz — has a bother
Leveraged CDOs they were after
Going — all the way down, with
Hey you need a downgrade now
Huge delinquencies hit it now
Bringing down the house.
video after the jump
MERRILL LYNCH MBS TRUST SUES BANK OF AMERICA OVER MBS –> Trustee Lawsuits beginning –> This is an important development in MBS litigation. *U.S. BANK AS TRUSTEE SUES MERRILL LYNCH AND BofA – REPRESENTED BY QUINN EMANUEL (SAME LAYWERS AS FHFA AND MBIA)
Hat tip Manal Mehta
The unregulated multi-trillion dollar derivatives market exceeds global GDP and poses a clear danger to the global economy, Chris Whalen, Senior Managing Director at Tangent Capital Partners, and Barry Ritholtz, CEO at Fusion IQ, tell Bloomberg Law’s Lee Pacchia.
“The fix is very simple,” says Ritholtz, “repeal the Commodities Futures Modernization Act and suddenly this becomes like every other financial instrument.”
Whalen notes that the financial industry is reluctant to change the way derivatives are managed because they generate large returns at a time when banks are less profitable than before. “The super normal returns that they earn from derivatives subsidize the rest of the business,” he says.
One way or the other, Ritholtz and Whalen believe the financial industry needs to get used to the idea of making less money.
Dec. 5 (Bloomberg Law)
One of the Main Indicators of Financial Danger Has Increased The failure to regulate the shadow banking system was one of the causes of the financial crisis. As we noted in 2009, the Bank for International Settlements – often described as a central bank for central banks (BIS) – slammed the Federal Reserve for failing…Read More
Fascinating quote from Nick Dunbar, author of The Devils Derivatives: “What would happen if VaR was taken out of bank regulation? Immediately, the intellectual crutch for highly-leveraged complex banks would disappear. Deprived of their fancy radar screens, regulators would have break up large banks that they could no longer pretend to understand, while increasing their…Read More
The amount of derivative exposure continues to dazzle and amaze (You can see the full report here: OCC’s Quarterly Report): Click to enlarge: Hat tip: Damien, an RIA in sunny San Diego.