Jesse Litvak

Now I normally don't take anything on zerohedge too seriously, but I've gotta say they've got this story down.

http://www.zerohedge.com/news/2013-01-28/we-are-doneski-gorgeous-how-bond-trading-wall-street-really-works

I'm imagining these quotes being read by Jesse Pinkman:

yo yo yo….if there is any color you can share on your wfmbs 06-ar10 4A1 from yest…maybe i can use that as leverage to go beat the guy up that owns the 06-ar12 1a1 bonds

Someday, hopefully soon, investors will demand an end to these shenanigans and move all fixed income and derivatives trading to exchanges.

Retirement

No I'm not retiring from blogging, but I did just read a very interesting op-ed on retirement policies in the new york times.

http://www.nytimes.com/2012/07/22/opinion/sunday/our-ridiculous-approach-to-retirement.html

The stats on how little people in the US have saved for retirement are depressing. Many people are facing poverty due to either lack of planning or poor decisions. Yes some people can keep working to ease the blow but many can't. And though I'm generally against government intervention its clear the current system needs to be fixed. Retirement is an area where I feel the ideas of libertarian paternalism are most applicable. If someone doesn't want to save for their retirement that should be their choice, but right now we have an opt-in system - meaning that the default choice is don't save. If the government mandated an opt-in system the evidence suggests people would save a lot more. Under such a system you're automatically enrolled in 401k contributions unless you fill out paperwork to the contrary. Furthermore the government should mandate that all companies offer everyone better low cost investment options and make it more difficult to withdraw money. I follow all this stuff pretty closely and it still feels overwhelming at times! And I manage risk professionally. I can't imagine how someone without all that experience must feel. All this is basically at the heart of libertarian paternalism, let people do whatever they want but nudge them toward better options.

Kelo strikes again?

Article in rolling stone about a plan to use eminent domain to seize foreclosed houses and write down mortgages en masse. San Bernadino County is at the forefront of this plan and its pissing off a lot of bankers. I think this plan is brilliant and has the potential to reshape the housing market for the better... that said I should probably drop my position in BAC.

http://www.rollingstone.com/politics/blogs/taibblog/from-an-unlikely-source-a-serious-challenge-to-wall-street-20120720

Trial about no potential for jail-time

Banker from Citi is being charged by the SEC with negligence for some CDO deals. But if criminal bankers only have to give up a portion of their ill-gotten gains it won't serve as much of a deterrent. Start throwing them in jail and people will think twice about lying to investors, defrauding clients and manipulating markets.

http://www.ft.com/intl/cms/s/0/a5e535f6-cd1f-11e1-b78b-00144feabdc0.html#axzz20n9l2D6W

LIEBOR

After subprime mortgages, shadow banking and robo-signing I shouldn't be surprised by another fraud that the banks have gotten themselves into. There's a good article in the economist describing what exactly Barclay's (and inevitably others) are guilty of:

http://www.economist.com/node/21558281

LIBOR (london inter-bank offered rate) is everywhere, anyone who borrows or saves money is touched by it. The fact that these banks were brazen enough to manipulate this rate for their own profit is appalling. As the scandal spreads so will the outrage. In previous scandals the banks were generally ripping off "sophisticated investors" i.e. greedy people who should have known better. But scandal takes their fraud to a whole new level. Litigators must be thrilled about this - shit's about to get real.

The Next Shoe to Drop

Ever since the subprime debacle lots of folks in the industry have been worried about commercial real estate mortgages (i.e. multi-million dollar mortgages for office buildings, apartments, malls etc). But the commercial crash never really materialized despite lots of vacancies. This author attributes that to bias at the banks, but I don't think that's the primary reason:

http://www.marketplace.org/topics/business/easy-street/one-financial-crash-we-avoided

The biggest reason in my mind is leverage. During the go-go years you could buy a house with 5% down or less! This causes two problems. First if you're only putting a few thousand dollars down instead of tens of thousands have you really thought this decision through? And second if you only put 5% down then a 20% drop in house prices puts you hella underwater - unable to move, unable to refinance. Worse still, after the crash in house prices banks face an incentive compatibility problem. Financially its in their best interest to reduce your principal and get as much as they can from you. But if they do this for one person then tons more people will stop paying their mortgages trying to get their principal reduced and the banks would be screwed.

But we don't have this problem with commercial mortgages. In the commercial world 40% down payment is the standard and almost no one is allowed to put less than 25% down. So even if commercial property prices drop 40% (as they have) the property securing the mortgage is still valuable enough to cover the mortgage! I feel this is the key difference, if borrowers stop paying the bank can seize the property and not lose any money. Consequently there is no need to reduce principal, no incentive compatibility problems. Instead the banks can work out extensions, lower rates etc and everyone is happy. What happened with residential mortgages is that people took out too much debt and consequently were too leveraged. No doubt a good portion of this was reckless speculation and runaway consumption, but soaring health care and education costs also played a big role. These consistently rank as two of the top uses for home equity withdrawals. The more I think about this the more I feel our economic issues are all interconnected.

More on JPM

Great post from financial times' blog on JPM's trade that blew up:

http://ftalphaville.ft.com/blog/2012/05/11/996131/too-big-to-hedge/

I don't blame Dimon, how can anyone possibly keep tabs on all $2 trillion of JP Morgan's assets?

Moral Hazard Bitches

JP Morgan just announced a $2B trading loss with more certainly to come as they unwind their positions. Given how big this loss was the size of their position must be tremendous. Blood on the Street.

http://online.wsj.com/article/SB10001424052702304070304577396511420792008.html

Who in the world approved this? Actually a quick Google search yields an answer:

http://money.cnn.com/galleries/2011/fortune/1109/gallery.highest_paid_women.fortune/8.html

And more importantly why in the world are too big to fail banks still prop trading?!?

Leaving Banking

Two great stories about people who left wall street / i-banking. They pretty much give all the reasons why I didn't get into this in the first place.

http://nplusonemag.com/leaving-wall-street

http://www.wallstreetoasis.com/forums/life-after-investment-banking

This sounds like reality TV

A professor at USC's business school followed two dozen business school graduates through their first few years working at investment banks in New York. I for one am not surprised at what she found:

http://online.wsj.com/article/SB10001424052970204062704577223623824944472.html?mod=WSJ_article_MoreIn_Health

I'm more surprised that only one-fifth of the bankers left after 4 years!

I just looked up moral hazard in the dictionary...

and it said "See Freddie Mac":

http://www.propublica.org/article/freddy-mac-mortgage-eisinger-arnold

I'm sure a lot of the folks doing these Freddie Mac deals are the same geniuses that traded CDOs 5 years ago. And I'm not using genius ironically here, they are actually very smart people who know how to take advantage of the system. The problem is (and has been for the past decade) that legal and moral aren't necessarily the same. Traders at Freddie Mac stand to gain billions if homeowners who are stuck in high interest rate mortgages are unable to refinance their mortgages. If a hedge fund made this trade I'd have no problem with it - its a perfectly legal transaction and helps the market price mortgage securities. My problem is that Freddie Mac determines whether these borrowers qualify to refinance or not. That completely messes up the incentives, this trade lets Freddie Mac profit by excessively tightening its refinancing standards. If that weren't bad enough Freddie Mac is now owned by taxpayers. Think about this for a second, our own government is giving Freddie Mac about $2 billion per month so that they can force thousands of homeowners to pay above market rates and collect bonuses. I'm less offended by the people doing this than the legal system that allows this to happen.

Matt Taibbi

I can't decide whether this guy just wants attention or whether he actually believes the stuff he writes. At one point he described Goldman Sachs as "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." But in his blog this week he makes a good point, when Goldman tells you to buy, more often than not you should sell.

http://www.rollingstone.com/politics/blogs/taibblog/goldmans-latest-boiler-room-stock-america-20120102

Next on my reading list

Interesting article in Forbes about a new book: What Capitalism can learn from the NFL

http://www.forbes.com/sites/stevedenning/2011/11/28/maximizing-shareholder-value-the-dumbest-idea-in-the-world/

Martin compares the idea of maximizing shareholder value as trying to cover the point spread in the NFL rather than trying to win the game. Targeting the real market instead of the expectations market could do capitalism a lot of good. Too often management has the incentive to maximize short term profits at the expense of long term growth. What's worse is that this pressure often comes from the shareholders themselves. I just hope the book is as good as this article.

Operation Perfect Hedge

Based on this article from Bloomberg it sounds like the FBI is using similar tactics to prosecute insider trading at hedge funds as they used for organized crimes and gangs. I hope somebody makes an HBO show along the lines of "the white collar wire." True most of these millionaire hedge fund managers aren't shooting people and selling drugs but the cost of their actions still totals hundreds of millions of dollars. The public does't get as upset because if you defraud millions of people for a few dollars each it's not as startling as defrauding an individual for a few million. That's what makes these crimes so difficult to prosecute the victims are spread out all of the world and its practically impossible to recompense them. To some extent this is the cost of investing, you're going to lose some money to fraud. As long as authorities keep these costs low investors will have faith in the system, if the insiders are allowed to run amok everyday investors will head for the hills.

http://www.bloomberg.com/news/2011-12-20/fbi-pulls-off-perfect-hedge-to-nab-new-insider-trading-class.html

My job

Good article from Chance Magazine pretty much sums up the work I've been doing for the last few years. It's titled Model Risk and the Great Recession.

SEC settlement with Citi

Today Citi settled with the SEC for nearly $300 million over a structured CDO deal. Seems like every bank is going to face these kinds of lawsuits.

http://online.wsj.com/article/SB10001424052970204618704576640873051858568.html?mod=googlenews_wsj

What's interesting about this specific settlement is that it names an individual - Brian Stoker. Most of the settlements are very generic sounding and don't call out anyone. So of course I'm curious and I look him up on linkedin - turns out he's only 3 degrees of separation from me. Looking at his work history he went from VP at Merrill Lynch to Director of Structured Products at Citi and now he's an Analyst at some private equity shop. Ouch. Sounds like that structured products experience is a liability these days.

Remember Meredith Whitney?

Last year she predicting "hundreds of billions" in municipal bond defaults for 2011. So far she's waaay off, in the first half of the year there were $511 million of muni defaults. However that number is almost going to double today as Harrisburg filed for bankruptcy. Still a far cry from "hundreds of billions" but if it works out well for them maybe other heavily indebted municipalities will follow suit. There are certainly no shortage of those.

http://www.reuters.com/article/2011/10/12/harrisburg-bankruptcy-idUSN1E79B0DS20111012

Blame the investors

Martin Wolf has a great post about how high target returns on equity are creating financial instability:

http://blogs.ft.com/martin-wolf-exchange/2011/09/25/what-do-the-banks%E2%80%99-target-returns-on-equity-tell-us/#axzz1Z414EqVF

Banks love using the line "without high returns (and consequently leverage) we won't be able to attract equity investors." Bullshit. What will happen is their stock price will go down until its attractive to investors again. Every equity investor wants the bank to take as much risk as possible. They have unlimited upside and limited liability so they can't lose more than their original investment amount. What typically keeps the banks in line are creditors, they receive a fixed return on their investment but can still lose everything if the bank really screws up. Unfortunately in our Too Big To Fail world the creditors can't lose money either. If we bail out bank creditors (who are often other banks) there is no market check on the risky investments of banks. Without this system of checks banks will take as much risk as they possibly can, staying one step ahead of regulations. Banks are supposed to be prudent stewards of capital and risk management is supposed to be their primary business. But now our banking system is less stable than before, perhaps banks have better capital positions but these won't last long as equity investors demand higher returns (more risk).

I have this comic on my wall at work:

Bank of America's latest problem - too much money

Due to all the turmoil in Europe deposits are leaving European banks and finding their way into US banks. However US banks don't want this money, with interest rates at 0 its impossible to find profitable ways to invest it - they may even be losing money on these deposits. Plus no one thinks these deposits are going to stick around for long so banks unwilling to invest them in longer term assets.

http://www.bloomberg.com/news/2011-08-26/u-s-banks-said-to-seek-relief-from-regulators-as-deposits-swell.html

All this is making me wonder - are low interest rates the cure or the disease? Maybe they need to start considering alternative investments. Perhaps a Scrooge McDuck themed amusement park?

Kill kill kill kill... the quants?

Quants have been taking a lot of heat in recent years, first it was all those CDOs that went bust, now every blip in the market is blamed on high frequency traders. Certainly there's some truth to it, but this guy is really taking it too far:

http://www.thestreet.com/story/11229935/1/kill-the-quants-before-they-kill-us.html

This guy makes it sound like there was no such thing as volatility before HFT came along - come on! First of all the quants do the research and make the models, they're not the ones who decide to leverage 30 to 1 putting the financial system at risk. Second, who is really hurt by a 6% move in the stock market? If you can't stomach the occasional 50% loss then you shouldn't be investing in stocks anyway.