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Noah Smith, John Taylor uncovers a hideous threat to our freedoms, here. Uh oh, Noah’s back.
In a recent speech at Stanford former Wells Fargo Chairman and CEO Dick Kovacevich told the full story of how he was forced to take TARP funds even though Wells Fargo did not need or want the funds. The forcing event took place in October 2008 at a now well-known meeting at the U.S. Treasury with Hank Paulson, Ben Bernanke, as well as several other heads of major financial institutions…
DealBook, What’s Next After the Barclays Settlement, here. Ok, it turns out the risk free rate was even riskier than AA unsecured interbank lending in several ways. NYT looking to see if some of that risk will jump the pond. This is another example of why code is so very much better than data.
The settlement by Barclays over accusations that it manipulated the benchmark London interbank offered rate, or Libor, is like the first crack of thunder signaling a coming storm; the question now is how big the storm will be.
Matt Taibbi, Why is Nobody Freaking Out About the LIBOR Banking Scandal? here. Taibbi is certainly looking to get some of the Libor risk state side. Taibbi does not care about the data, he’s more of users advocate, I guess. Maybe advocate is the wrong word. Pretty sure, he wants some of the users to go to Rikers Island and some to just carry on reading The Rolling Stone.
Anyway, the LIBOR story is leading the front pages of most of Britain’s dailies, it’s on TV, and it’s producing blistering editorials and howls of outrage amongst politicians and activists. But as compadre Yves Smith at Naked Capitalism put it, where’s the outrage here in America?
Naked Capitalism, Liborfest links 3 Jul, here and 4 Jul, here. Yves Smith is sanguine about Treasury’s chances today. Naked Capitalism is scouring the web for Libor links. See also from 3 Jul Mirabile Dictu! Barclays CEO Bob Diamond Resigns Over Libor Scandal (Updated), here. There is blood in the water, but we have seen time and again Rates doesn’t have the same pull on the public attention as Domestic Retail Equity. Joe and Suzy Sixpack might track FB news a bit but Euribor, not so much.
Liborfest! And sadly, I’m going to be on a plane when the Treasury hearings are on. If readers can point to live feeds (for those Libor junkies, some have written asking for leads) and any sites that have either the recording for later viewing or a transcript, that would be very much appreciated.
In general, I’d not bet on an American CEO when matched against Oxbridge educated regulators. Just the British mastery of the language puts Yanks at a disadvantage. And they aren’t used to the more direct style of questioning either.
John Carney, CNBC, Business Insider, here. Reports that NY BarCap folks push Diamond off the ledge because they did not want another Dick Fuld.
Senior investment bankers in New York began to organize a coup on Monday. Several met in the New York offices, which were formerly the offices of Lehman, to figure out a strategy to force Diamond to step down.
The main obstacle they faced, many believed, is that the London-based board might not respond favorably to demands from New York-based investment bankers. Some feared it could be seen as a Lehman plot against the Barclays management.
“This was bringing up a lot of old wounds still festering from the acquisition,” a person familiar with the situation said.
Some in New York believed that the damage to the bank’s reputation if Diamond had stayed on would have been lethal.
“We’re just recovering from the Dick Fuld fiasco,” one senior investment banker said, referring to the Lehman CEO who presided over the firm’s collapse in 2008. “We couldn’t have another out of touch executive at the top.”
Joe Weisenthal, Business Insider, Barclays Nukes The Bank Of England, And Basically Accuses It Of Being Behind Their Interest Rate Manipulation, here. Do not mess with the Queen after the Jubilee.
Subsequent to the call, Bob Diamond relayed the contents of the conversation to Jerry del Missier. Bob Diamond did not believe he received an instruction from Paul Tucker or that he gave an instruction to Jerry del Missier. However Jerry del Missier concluded that an instruction had been passed down from the Bank of England not to keep LIBORs so high and he therefore passed down a direction to that effect to the submitters.
Matt Levine, DealBreaker, Maybe Bob Diamond Manipulated Libor For Queen And Country? here. I’m putting a buck on Levine’s take here, its the bromail and P&L that threatens to turn this into a full out frenzy. That might answer Taibbi’s question on why the risk doesn’t jump the pond so quickly. You gotta find the bromails.
My own guess is that Barclays wouldn’t be such a piñata if that was all it had done: if it had lied about Libor just to boost confidence in itself, with perhaps a nudge-and-wink assist from the BoE, there might well be a shrug of “well everyone kind of knew that.” (Certainly the BoE did; Mervyn King went around saying that Libor was “the rate of interest at which big banks don’t lend to each other,” which I’m sure he regrets a bit now.) Propping up confidence in a bank’s viability, even dishonestly, is a venial sin – as long as the bank remains viable.
The problem for Barclays was that its traders also manipulated Libor not to preserve confidence in the bank and the banking system, but to boost the P&L on their own trades. That sort of outright zero-sum fraud, documented in voluminous terrible emails, is harder for regulators and the public to tolerate. The irony is that those manipulations probably didn’t have all that much effect, relatively speaking: they were on the order of a half basis point every now and then (er, every day, whatever), and more crucially Barclays’ traders at least thought they were shooting against other banks manipulating Libor the other way. So the net effect on rates may have been small. Whereas in the depths of the financial crisis, Barclays was pushing down its submissions to be “in the middle of the pack” at the same time that other banks had incentives to do the same, and probably did. “Everybody’s doing it” then made the problem worse, not better – though it might also have made it easier to forgive.
Felix Salmon, Defiant Barclays, here. The Queen is not amused.
The resignation of Bob Diamond notwithstanding, it seems that Barclays is sticking to its scorched-earth, if-we’re-going-down-we’re-taking-you-with-us strategy. In its submission to the UK parliament in the run-up to Bob Diamond’s testimony tomorrow, Barclays is very aggressive and not at all contrite.
Can Barclays be salvaged? here. Setting the snark to 11.
I suspect the best bet for Barclays’ board and its new CEO, whoever that turns out to be, will be to get out in front of Vickers, and make a virtue out of necessity. Ringfence all the UK retail-banking operations and turn them into a boring utility. Then take everything else, including the whiz-bang traders and investment bankers, and list them as a separate company, most likely in the US, which can take on as much risk as its regulators allow it to. I believe the LEH ticker is still available.
Izabella Kaminska, Alphaville, Euribor has been vaporized, here.
Not our words, but those of Richard Comotto of the European Repo Council.
In case readers are not familiar with Mr Comotto, he’s the author of the ICMA’s semi-annual survey of the European repo market — probably the best (if not the only) overview of the repurchase market in Europe.
Comotto’s job involves interviewing repo market participants throughout the year, in a bid to try and understand what’s really going in the repurchase world.
The reason his study is so valuable, meanwhile, is because nobody else really does the same thing, and statistics remain hugely scarce in the market.
Barcap, Supplementary information regarding Barclays settlement with the Authorities in respect of their investigations into the submission of various interbank offered rates (AMENDED), here. Looks to me like they are going with Society is to blame.
The structure of the material that follows is intended to provide a framework through which to interpret the various events. To aid that, it also includes:
A chronology covering the four issues examined by the investigating authorities. This is important to avoid the issues being conflated and confused. It is particularly important to recognise that the trader conduct was separate from the conduct during the credit crisis and characterised differently by the Authorities. The actions of the traders were regarded as an attempt to manipulate ultimate reference rates. The actions of Barclays during the credit crisis were not.
A timeline summary of the principal documented contacts between Barclays and the Authorities during the financial crisis period relating to LIBOR submissions. We believe that this chronology shows clearly that our people repeatedly raised with regulators concerns arising from the impact of the credit crisis on LIBOR setting over an extended period.
A graph showing our 3 month USD LIBOR submissions relative to others during periods of the crisis and the occasions on which our submissions were excluded from the rate setting process as too high.
WSJ, Market Watch, Barclays says BOE, Fed knew of Libor concerns, here.
On a day when both the chief executive and chief operating officer of Barclays PLC resigned over an interest-rate fixing scandal, the U.K. bank released its own version of events and suggested Tuesday that Bank of England and Federal Reserve officials were well aware of the issue.
Lisa Pollack, Alphaville, Regulator captured, a case study, here. This is like a discussion of what exactly was wrong with Capone’s tax records and how he could have done a better job in tax preparation to avoid legal problems down the road. Depending on how JPM books the London Whale’s hedge position and the underlying it is entirely possible there are portions of the aggregate position that are absent from the VaR ( or so grossly approximated that the MTM dynamics are effectively absent from the VaR). If there isn’t a massive story about where the London Whale P&L went, then this is a story about the model used by the London Whale to manage the books. The regulator VaR vision is not likely to give a big heads up that the CIO management are going to notice. The interesting question here is how did the position control escape from the quantitative model the London Whale was actually using to manage his book.
These are all real smart people. Here is an educated guess on how this went down:
They probably ran the Gaussian Copula on Credit portfolios back in the day of the SCDO. They saw the historical correlation calibration break down in 2005, 2007, and finally 2008. They got a supercomputer in 2009 to run the Gaussian Copula. Took three years to port the code to FPGAs, made movies about how they ported the code and put them on You Tube, found a new correlation calibration mechanism and reloaded correlation trading via GC in standard tranches in 2012.
The WSJ reported on Thursday that JPMorgan’s regulators will conduct a thorough review of the bank’s models, according to “people close to the situation”.
Thanks to a letter from the the Office of the Comptroller of the Currency to Senator Sherrod Brown, we know that one particular model — the VaR model that JPMorgan’s Chief Investment Office switched to in January 2012, and which failed to alert management to outsized risks the division was taking — did not require regulatory approval before being used.
It is therefore understandable that regulators are trying to pick up the pieces of their own damaged reputations by conducting a big model review.
But that won’t be enough.
Al Pacino, Any Given Sunday, here; or Clint Eastwood, here. Now we are going to have to endure a seemingly endless stream of Taleb’s gloating i-have-been-warning-you-about-VaR-for-years interviews; the FinQuant equivalent of the Icky Shuffle. Look Team Firm Risk, you all have seen It’s a Wonderful Life, right? Well every time a bank gets their bell rung, Taleb gets another Fox and Friends interview.
Naked Capitalism, JP Morgan Loss Bomb Confirms That It’s Time to Kill VaR, here.
One of the amusing bits of the hastily arranged JP Morgan conference call on its $2 billion and growing “hedge” losses and related first quarter earning release was the way the heretofore loud and proud bank was revealed to have feet of clay on the risk management front. Jamie Dimon said that the bank had determined that its value at risk model was “inadequate” and it would be using an older model. And no wonder. The Financial Times report contained this bombshell:
JPMorgan also restated its “value at risk”, a measure of maximum possible daily losses, of the CIO [the unit that executed the trading strategy that blew up] in the first quarter from $67m to $129m.
“Synthetic credit portfolio”. That’s the book where the $2bn in mark-to-market losses took place for JP Morgan, according to an announcement made on Thursday. A result which has now cost them a their AA- rating from Fitch and landed them on negative outlook with S&P, as announced late on Friday.
FT Alphaville has analysed the credit trades that might be in that portfolio, in an attempt to reason through what may have gone on. The fact, however, remains that we know precious little. Why is that? Is this acceptable that after the financial crisis that this can happen to a bank, let alone a systemically important one like JP Morgan?
Got a buck that says you cannot find a Firm Risk person on 13 May 2012 who knows substantially more about the positions than Lisa Pollack.
Zerohedge, Double or Nothing: How Wall Street is Destroying Itself, here.
This fragile business model is in fact descended from the Martingale roulette betting system. Martingale is the perfect example of the failure of theory, because in theory, Martingale is a system of guaranteed profit, which I think is probably what makes these kinds of practices so attractive to the arbitrageurs of Wall Street (and of course Wall Street often selects for this by recruiting and promoting the most wild-eyed and risk-hungry). Martingale works by betting, and then doubling your bet until you win. This — in theory, and given enough capital — delivers a profit of your initial stake every time. Historically, the problem has been that bettors run out of capital eventually, simply because they don’t have an infinite stock (of course, thanks to Ben Bernanke, that is no longer a problem). The key feature of this system— and the attribute which many institutions have copied — is that it delivers frequent small-to-moderate profits, and occasional huge losses (when the bettor runs out of money).
Roy Scheider, Jaws, here. Ok I was wrong, Mammoth Supercomputer needed to keep London Whale Afloat was not too much.
NYT DealBook, JPMorgan Discloses $2 Billion in Trading Losses, here.
JPMorgan Chase, which emerged from the financial crisis as the nation’s biggest bank, disclosed on Thursday that it had lost more than $2 billion in trading, a surprising stumble that promises to escalate the debate over whether regulations need to rein in trading by banks.
Jamie Dimon, the chief executive of JPMorgan, blamed “errors, sloppiness and bad judgment” for the loss, which stemmed from a hedging strategy that backfired.
The trading in that hedge roiled markets a month ago, when rumors started circulating of a JPMorgan trader in London whose bets were so big that he was nicknamed “the London Whale” and “Voldemort,” after the Harry Potter villain.
WSJ Deal Journal, J.P. Morgan Reveals ‘London Whale’-Size Losses, here.
J.P. Morgan Chase & Co., the nation’s largest bank, surprised the market today, saying it has taken large losses stemming from derivatives bets gone wrong in the bank’s Chief Investment Office.
At 4:30, the bank sent out an unusual notice saying that it would be holding a call at 5 p.m. but included no details about what the call would be about. A person familiar with the matter said the call would include CEO Jamie Dimon and discuss the bank’s quarterly filing.
On the conference call, J.P. Morgan CEO Jamie Dimon said the bank had taken $2 billion in trading losses in the past six weeks and could face an additional $1 billion in second-quarter losses due to market volatility.
DealBreaker, Whale Sushi On The Menu At JPMorgan Executive Lunchroom For Next Few Months, here.
Whaledemort remains something of a riddle wrapped in an enigma wrapped in barnacles, and the Q&A reflected that. BAML’s Guy Moszkowski and others pressed Dimon on, as Moszkowski put it, “why did you feel the need to add synthetic credit exposure?”; others asked a not-unrelated question, which was, roughly, “c’mon Jamie, was this guy actually ‘hedging’ or was this just a crazy prop bet?” Dimon’s answers were not super satisfying but they were clear enough: the Whale was hedging, not adding, credit exposure. But he wasn’t just doing that by getting short lots of bonds or buying lots of CDS. Instead, he was doing something that had him getting long credit via CDX – presumably massive flatteners or tranche trades that were relatively neutral to small moves in credit but made lots of money if things got rapidly worse. These were not prop trades, not massively long credit – rather, the Whale was long credit via longer-dated CDX and short credit via shorter-dated CDX and/or tranches.
That is a simple enough trade, for some value of “enough,” but apparently not simple enough for JPMorgan! At some point they decided to reduce this credit hedge, or “re-hedge” it (Jamie’s exact words vary but whatever, you get the idea, they were short credit through some things and they decided to reduce that short position in some fashion by getting long more CDX or closing some of their shorts or whatever), and that re-hedging was “flawed, complex, poorly reviewed, poorly executed, and poorly managed” but otherwise fine. Except that, also, they fucked up the model.
Salmon, JP Morgan: When basis trades blow up, here.
I’m not sure if it was the biggest quarterly loss of all time, but Merrill Lynch’s $16 billion loss in the fourth quarter of 2008 certainly ranks very high up there in the annals of investment-bank blowups. It happened after the bank had already been taken over by Bank of America, and it was in the middle of the financial crisis, so it didn’t get nearly the amount of attention it deserved. But it was not simply a case of assets plunging in value. Instead, it was, in very large part, a basis trade blowup.
The basis trade is an arbitrage, basically. There are two different ways the market measures credit risk: by looking at credit spreads — the yield on a certain issuer’s bonds, relative to the risk-free rate — or by looking at CDS spreads, which are basically the same thing but set in the derivatives market rather than the cash bond market. Most of the time, CDS spreads and cash spreads are tightly coupled. But sometimes they’re not. And at Merrill, a huge part of that $16 billion loss was reportedly due to a bad basis bet: the basis on many credits became very large and very negative during the financial crisis.
This time around, the basis-trade disaster has happened at JP Morgan, where the famousLondon Whale seems to have contrived to lose $2 billion on what was meant to be a hedging operation. And once again, although the details are still very murky, the culprit seems to be the CDS-cash basis.
Fast forward to early 2009 and Boaz Weinstein, the former star trader and co-head of credit trading at Deutsche Bank is down $1bn, Ken Griffin of Citadel is down 50% and John Thain’s Merril is said to be down $10bn+. Most of these horrific losses are due to a single strategy… the scary negative basis trade.
Bloomberg has written about it here
And there has even been a book published on this strategy… how many trades can say that!
There are a lot of moving parts in the Dismal tale of Dimon’s demise. The starting point is that Bruno Iksil in the JPMorgan CIO Office, under the premise of hedging the bank’s credit portfolio’s tail risk had placed various tranche trades (levered credit positions with various risk profiles) in the only liquid tranche market that still exists – CDX Series 9 (an ‘orrible portfolio of credits with an initial maturity at the end of 2012). These positions were low cost (steepeners or equity-mezz) but needed a certain amount of day to day care and maintenance (adjusting hedges and so on). As the market rallied, the positions required increasing amounts of protection be sold to maintain hedges (akin to buying into a rally more and more as it rises). His large size in the market left a mark however that hedge funds tried to fix – that was his index trading was making the index extremely rich (expensive) relative to intrinsics (fair-value).
Bloomberg, NYSE Tweaks Trading Prices to Appeal to High-Frequency Firms, here.
While the largest exchanges — including NYSE and Nasdaq — employ what’s called maker-taker pricing that pays those providing liquidity on their venue and charges firms executing against those orders, an alternative pricing setup has gained traction over the last couple years.
Four stock markets — BYX Exchange, EDGA Exchange, Nasdaq OMX BX and CBOE Stock Exchange – do the opposite of NYSE, paying traders to execute against orders at their markets while the firms that submitted those bids and offers are charged a fee. CBSX, one of the smallest stock exchanges, pays firms 18 cents, the highest rate, for orders executed immediately.
BYX is owned by Bats Global Markets, based in Kansas City, Missouri. EDGA Exchange is run by Direct Edge Holdings LLC in Jersey City, New Jersey. The companies run two exchanges each, and totaled 20 percent of U.S. equities trading in November.
Nasdaq OMX BX is also altering its pricing in January. It will pay firms executing immediately 14 cents instead of its current 2 cents, and will charge them 18 cents instead of 4 cents for providing orders. That pricing replicates what’s available on CBSX, owned by Chicago-basedCBOE Holdings Inc. and a group of brokers.
CBSX, based in New York, tested the pricing starting in August and expanded it to all stocks in October as it gained volume. In November, CBSX’s share of trading in Citigroup Inc., one of the most actively traded stocks, was 0.9 percent, compared with less than 0.1 percent a year earlier, according to data compiled by Bloomberg.
The Fiscal Times, Who’s Watching the Banks? here. Nice figure displaying the US Gov agencies charged with bank oversight.
Credit Crisis Summaries: Pollack/Alphaville, What five years of crisis history tells us, here. Chicago Policy Review, The View of the Eurozone Crisis From China, here. St. Louis Fed, A Look at Credit Default Swaps and Their Impact on the European Debt Crisis, here. US Treasury, Financial Crisis Response In Charts, here. IMF, Global Financial Stability Report, April 2012, here. Naked Capitalism , Andrew Haldane on the Arms Race in Banking, here. Thoma, 60 Minutes video The Case Against Lehman Brothers, here.
Electronic Publishing: The Atlantic, The Justice Department Just made Jeff Bezos Dictator-for-Life, here. Charlie’s Diary, What Amazon’s ebook strategy means, here. The Register, Apple fights off ebook suit with anti-Amazon defence, here. Carr/NYT, Book Publishing’s Real Nemesis, here.
Cringely, Not your father’s IBM, here. Cringely is on the warpath.
This is my promised column about IBM — the first of several on the topic, all to be delivered this week. The last time I wrote at length about Big Blue was in 2007. I have been asked by readers many times to revisit the subject, something I haven’t wanted to do because it is such a downer. Writing the last time I hoped the situation, once revealed, would improve. But it hasn’t. And so, five years later, I turn to IBM again. The direct impetus for this column is IBM’s internal plan to grow earnings-per-share (EPS) to $20 by 2015. The primary method for accomplishing this feat, according to the plan, will be by reducing US employee head count by 78 percent in that time frame.
Reducing employees by more than three quarters in three years is a bold and difficult task. What will it leave behind? Who, under this plan, will still be a US IBM employee in 2015? Top management will remain, the sales organization will endure, as will employees working on US government contracts that require workers to be US citizens. Everyone else will be gone. Everyone.
Reuters, Man Group to launch computer-driven bond hedge fund, here.
“Traditional fixed income investing (is) unattractive,” Man’s Systematic Strategies unit said in a note, citing “yields close to zero percent, increased credit risk in many government bonds, (and) little upside (and) big downside of being long bonds in (the) current environment.
“Market inefficiencies (are) likely to prevail in fixed income markets, creating investment opportunities.”
eBooks: You can purchase eBooks from JK Rowling Pottermore, Umberto Eco Homepage, or Neal Stephenson Homepage. I think JK Rowling is kind of all your base are belong to us compared to these guys in the eBooks sales department.
i Programmer, Google Glass – The Microsoft Version, here.
What would the Google Glass project look like if Microsoft got its hands on it? A new video shows exactly what it would be like.
Bloomberg, JPMorgan Said to Transform Treasury to Prop Trading, here. Mapping out the structure and mandate for CIO desk trading at JPM.
Zerohedge, Bruno Iksil, JPMorgan and the Real Conflict with Credit Default Swaps, here. Durden talks his book tirelessly, but can also produce very tight descriptions of fundamental market issues. The flow of information and influence between the corporate loan book and the default swap book in a highly consolidated market is something to think about.
WSJ, J.P. Morgan: A London Whale? He’s More of a Shrubbery, here. That never gets old, good one! However, I do like the quote about the regulators “see everything we do whenever they want.”
Russel Sage Foundation, Rethinking Finance, A conference on the economic lessons from the financial crisis, here.
Some economic events are so major and unsettling that they “change everything.” Such is the case with the financial crisis that started in the summer of 2007 and is, in several respects, still ongoing. Yet enough time has now elapsed for economists to dig deeper than the usual focus on the immediate causes and consequences of the crisis. How have these stunning events changed our thinking about the role of the financial system in the economy, about financial innovation, about the efficiency of financial markets, and about how the government should regulate finance?
To address these issues, the Russell Sage Foundation and The Century Foundation have convened some of the nation’s most renowned economists for a conference on what we have learned from the financial crisis. Four panels of experts will share their assessments of discrete aspects of the crisis, point to changes that should be made in the financial industry, in government regulation, and in the thinking of economists. The panelists will also take questions from conference participants in what we anticipate will be a lively exchange of opinions on the lessons of the financial crisis. Federal Reserve Chairman Ben S. Bernanke, an outstanding scholar of economics and finance in his own right, will offer his thoughts on lessons learned from the crisis in a lunchtime speech.
In particular take a look at the papers, here. Jarrow, Hull & White, Malkiel, DeLong papers each look solid.
The Columbus Dispatch, Club once snubbed disguised Fischer, Shelby Lyman, here. Lyman announced Fischer v. Spassky on PBS. Before Lipton on Godel’s Lost Letter or Tao on What’s New there was Lyman on PBS.