Financial crisis
Libor Fixing Scandal in the Grand Scheme of Things
“Save me from these evil deeds before I get them done.” Fiona Apple
The Libor fixing scandal is really not a very entertaining story. It’s a boring scandal. There’s no evil masterminds, no clandestine operations. Calling it a sham would give real sham a bad name. Fixing the Libor is as simple as tweaking the golf ball closer to the hole. It comes down to this: Libor rates are what I say they are.
The traders who were fixing the Libor didn’t think they were doing something wrong. Everyone else was doing it, so why should they be any different? Why stick your neck out? In such a high-five, fratboy culture it’s a bad taste to stand out. They don’t even have to be scheming bad guys for participating in the fixing. There was simply no coherent alternative mechanism to report those rates independently. If they don’t play the game the way everyone is playing it then their book will take a hit and they won’t get a bonus. But there’s a family to feed, kids to send to college, mortgage to pay. The little tweak here and there, in the grand scheme of things, wouldn’t do much damage. The accounts skimmed of a few basis points won’t even notice it and if there’s no victim there’s no crime. Add to this the desire to “not look bad” and fear of being “out of the loop” and you have a perfect mix that makes otherwise good guys do bad things. And if fudging the numbers is rewarded the incentive becomes even stronger. The reward is personal and immediate and the results of your actions are tangible. The loss is borne by many customers who won’t even notice that they have been shortchanged. I mean what are the benefits to blow the whistle? The participants are like members of a small cult – if you’re in on it you get the benefits, if you speak out you’ll be ridiculed and ostracized, besides whom are you going to complain to – the Fed? The SEC? Nobody wants to be a martyr, especially for such an obscure and unsexy, to an average observer, matter. If there’s no upside in exposing the weakness of the system to the feds, one will find an upside in exploiting these same weaknesses to his advantage. And try to explain to the general public why they should care about a few corporate investors being scammed of a few basis points on their investments when people lose their homes and jobs left and right? It’s not like selling toxic securities to unsuspecting customers, for Christ’ sake!
The more interesting story here is how this sort of “enchantment” has spread to the regulatory quarters. After all it’s hard to blame bankers for this sort of behavior – that’s what bankers do, they are in business to exploit every opportunity to make money.
The emerging story now is that the Fed and Bank of England might have known about the fixings. If Bob Diamond’s reasoning goes along the lines: I was just of many, we didn’t want to stick our neck out, then what is the reasoning for the Fed for not to have done anything? What was the risk for the Fed to get involved? I really don’t know why regulators didn’t do their job, or rather, I have many reasons that come to mind. The best analogy I would use to describe their actions is that of parents of a misbehaving child on the plane, careful not to take any drastic measures to rein him in and subject everyone to even more annoying cries. Sure, they have powers to discipline but it would create noise, and they just don’t want to face those disapproving passengers and would rather keep the whole thing as is. Child, of course, is perfectly aware of this kind of dynamics and is exploiting it with impunity.
But there’s some twisted beauty in the entire predicament. Everyone looks bad or at the very least disingenuous. Republicans, no friends of regulations, are now going to investigate why the regulators weren’t tough enough. “Some news reports indicate that although Barclays raised concerns multiple times with American and British authorities about discrepancies over how Libor was set, the bank was not told to stop the practice,” Representative Randy Neugebauer, a Texas Republican and the head of the House oversight panel, wrote in the letter to the the NY Fed looking for transcripts of phone calls between Fed and Barlcays officials. Such tough stance is commendable but how can we be sure that there’s no politics involved in this sudden conversion, given his and other Republican’s historical hostility towards regulations?
Wall Street is gleeful every time the public focus shifts onto regulators. You know, we weren’t policed like we were supposed to, what did you expect us to do – follow the rules unsupervised? It’s reminiscent of last summer’s British hacking scandal where Rupert Murdock-controlled media defended the actions of those involved in the hacking along the lines: “Sure there were some misdeeds, but look at the police! Why didn’t they police us? How could they let us do this?” There was nobody there to “keep me from these evil deeds”. Got it? Now leave us alone, if you can’t even enforce your own rules.
That’s a tactical mistake. The fact that regulators have tacitly approved or simply decided not to intervene into business as usual does not let bankers off the hook. In fact it kills one of their major arguments about regulations being too aggressive. As soon as the public sees that regulators didn’t do their job it becomes harder to convince us of the Wall Street-peddled notion that regulations are an impediment to a normal flow of business. All the cries of heavy-handed regulators are a fantasy, simply because such regulators never existed. Bankers can’t have it both ways: they either suffer from too much regulation in which case they admit that regulators actually have some pull; or they proceed to do their business because regulators are too weak in which case their complaints about regulatory hurdles and heavy government oversight that harms business are a simple disingenuous posturing. You can’t claim to be a victim of watchdogs and at the same time blame watchdogs for being dumb, inept and disorganized. And if you claim to be a victim of dumb, inept and disorganized watchdogs then you are simply too stupid to be in this business.
Righteous indignation of the public has worn itself out at this point. While this scandal affects trillions of dollars of investments that are reliant on Libor rate, the headlines of wrongdoings on Wall Street fail to shock at this juncture. This is business as usual. The beauty of Wall Street crime is that there’s almost never a smoking gun, or a dead body. If a wrongdoing occurs the bosses blame the subordinates, the subordinates blame the bosses and the corporate lawyers find a technicality that absolves all parties.
The victims of this scandal are not average Joe Schmos who lost money on their mortgage, but major financial institutions and municipalities who invested in Libor-linked securities. If regulators, lawmakers and ordinary people can’t police the banks then those institutional investors are our last recourse. I wonder if some of them can find the will to engage with Wall Street in the following manner: http://www.youtube.com/watch?v=mbwqeSV8Wc4
You think they’ll get the point?
Jamie Dimon wins this round.
After listening to Jamie Dimon’s testimony before Congress the other day I became less enthusiastic about Volcker Rule. No, I didn’t suddenly turn into a laissez faire supply-sider, I simply became more convinced that if such matter is entrusted into the hands of regulators we would have to be dependent on these regulators struggling with definitions, like what a hedge is. That would be too painful to watch.
I have to admit that, perhaps, capital requirements and other Basel III rules can be more effective than outright ban on certain kinds of trades.
My comrades on the left might disagree. But think about it: banning something outright will simply ban it on paper but in reality such ban will not prevent smart and resourceful Street guys from finding ways around it. Even potheads could for years find ways around the drug laws. Moreover, a sweeping ban will make a great excuse for the ever-complacent or complicit regulators to fall asleep again while giving the public the illusion of things being under control. Besides, show me any ban that has prevented people from obtaining/providing the illegal goods or services. What would prevent various exceptions and exemptions from being forced quietly into the legislation that renders the entire brick wall between deposits and trading desks useless?
Jamie Dimon and many others on Wall Street want regulations to be simple and effective. So do I. And so do regulators, I suspect, who are helpless in the face of complexity. Having capital requirements will be hard not to enforce simply because it’s quantifiable. All they have to do is build a spreadsheet where column B is needed capital and column C is actual capital, subtract one from the other and voila, there’s the list of those who meet the criteria and those who don’t. I’m being slightly facetious and simplistic, but you get the idea. Much easier than wrestle over definitions of what is a “directional trade” or a “macro hedge” with those who made a career out of twisting the terminology. Arguing over a definition of a “hedge” is a battle that the regulators, in their current state, can’t win.
It was almost comical to see senators asking Jamie Dimon his opinion on how to regulate the financial system. Here’s Jamie Dimon’s idea of sensible regulations: Proper capital requirements, proper liquidity, proper risk management and risk controls. It does not sound unreasonable at all. I could almost sense the slight disappointment among some (mostly Republican) Senators as they haven’t received anything less of “let the market take care of it”. The whole Senate testimony was worthy of a Monty Python’s skit in its absurdity, as the only voice of reason was coming from a Master of the Universe (Tom Wolfe accurately described this dynamic almost 25 years ago in his Bonfire of the Vanities). I wonder what was going on in Jamie Dimon’s mind at that point, but if I had to speculate I’d say disbelief, amusement mixed with a breathtaking realization that he’s the sole de-facto arbiter of a system that affects millions of people and trillions of dollars.
Meanwhile, capital requirements under current Basel III rules would have prevented Goldman from buying CDS contracts from AIG, for example. Or at least they would require Goldman to post higher capital in these kinds of trades to account for the risk of AIG becoming insolvent. While we can’t be sure such a trade would not have been done, we can be sure it would have been much smaller in size.
If OTC derivatives have been cleared through the exchange, there would be no high-stakes “who has what” poker game going on between the biggest financial institutions, trying to figure out who has what in ‘Assets available for Sale’ section of the balance sheet or other hard to decipher nicknames given to toxic assets. These holdings would have been more transparent. Thus, as Jamie Dimon rightly pointed out in his testimony, JP Morgan would not have been asked to take the bailout package, as everyone would see their minimal exposure to the crappy assets, compared to other firms. Thus, it is quite possible, that the bailout could have been smaller and more targeted (to Citi and BofA) and not sweeping and imposing.
Look, I’d love to have regulators who are smart and capable of doing their job, but the truth is, they will always be at least one step behind, because they don’t have the capacity and the wits to anticipate what is the next product to be invented on the Street. Regulators are a reactive force, not proactive. Lawmakers proved to be no better at understanding the complexities of the current financial system and dealing with the repercussions. Good intentions are a poor excuse. What we care for are the results.
We also would like to offer some advice to Jamie Dimon and other Wall Street alpha dogs – be a mensch, stop being offended at being called names. It’s not Obama’s job to become friends with Wall Street. He plays his game – you play yours. At this point of their careers neither Jamie Dimon, nor Lloyd Blankfein nor many of others on top of the Wall Street hierarchy care about money – they care about their legacy. Right now none of them look like socially conscious tycoons of the 1900s, no strangers to consolidation and market manipulation, sure, but who nonetheless understood the long-term dynamics of the society and came to rescue the system with their own money when the circumstances called for it. And yet, the bar has been set so low, and in part by our own public servants, that even Jamie Dimon, a fox guarding the hen house, looks as having more integrity than the subservient watchdogs. As evidenced by ingratiating senators who are on Wall Street’s payroll, asking Dimon for advice on how to run things, all Wall Street’s powerful men’s grievances about unfair treatment look nothing more than a simple disingenuous posturing. Guys, let me break it to you: You run the freaking game! You don’t have to have a TV show (like Ace Rothstein in the Casino), or bring attention to yourself by verbal sparring with various politicians; you have to have the whole thing to be quiet. Please, no more displays of victimhood and defensive language. And I’d like to conclude by posing a question to Mr. Dimon to ponder: imagine a less sharp and more reckless man inheriting your job one day. Wouldn’t it be a fitting legacy for a man in your position to help build a system that is less dependent on someone having both superhuman qualities and spotless integrity and more dependent on built-in levers of control that work regardless of someone’s pedigree and ambitions?
Bernanke was right, inflation hawks were wrong.
Heavy news day today. Turns out inflation is kind of low, which vindicates Ben Bernanke’s view.
And for those inflation hawks out there, you guys are in the world of wishful thinking. I kind of knew that all along, and I’m just an amateur.
Conservative case for taxes and regulations.
Damn, Joseph Stiglitz beat me to it. I have been working on the related topic of why the top 1% should also be worried about current income disparity.
It’s no secret to anybody that Republicans in Congress in general and the top 1% of earners in particular are no big fans of taxes and regulations. In this post I’d like to demonstrate that this is a rather short-sighted view and, out of their own sheer self-interest, they should be for higher taxes and government regulations.
Imagine, you are a billionaire and the economic reality around you has been rather, shall we say, anemic. But why should you give a fuck? You’re set for life, live in a gated community, have private security, household help – in other words with money you can theoretically shield yourself from daily struggles that the peons face every day. There are many reasons why you should (give a fuck), beginning from the fact that, if you’re a billionaire, your worries are of a different scale, namely, you want to close deals, sell products and make smart investments. None of it can be done in a vacuum. You need a solid consumer base, a partner on the other side of the deal, people who want to buy when you want to sell, the suckers at the poker table if you will! In order to be the king of the hill, you have to have the freaking hill! You have to have a vast and robust middle class whose wages are rising consistently year after year. Henry Ford was no fool when he paid his workers high salaries – so that they could buy his cars. The taxes have been falling for the last 30 years but that did not bring the promised prosperity and jobs to the middle class. Let’s admit that we tried it and it didn’t work. 
I must also admit that the game that you played for the last 30 years is spectacular in its shrewd, take-no-prisoners ways: pushing for tax breaks and lobbying for favorable legislation, eliminating competition, skimming consumers. Congratulations, you won. Now you’re all dressed up and ready to play but there’s no one left to play with. Now you’re a lonely player at the poker table with mountains of chips in front of you, wondering why is it that no one wants to come and play with you. Maybe it’s because people have no more chips left. In real poker, as in most games, being the last guy standing is the most optimal and desirable outcome, because there are other tables and other games always readily available. But the point of a real life game is not to win the most chips, but to keep the game going, simply because we only have one table. Besides, taking chips and going home is anathema to any businessman worth his salt: chips are supposed to be working. Now that you have that picture of yourself with all the chips let me ask you: Will the dealer taking smaller rake from the pot (I’m drawing an analogy with smaller taxes here, for those who don’t play poker. The dealer takes part of every pot, a ‘rake’) offer real solution to the lack of players at your table?
Another, more mundane reason why you should support taxes is unpleasant visuals that can spoil your day, if you’re not a complete sociopath. Do you like seeing bums on the streets or on subway trains, or, especially heartbreaking, neatly dressed middle-aged, resumes in hand, standing in unemployment line? Neither do I. Conservatives’ standard solution to this kind of situations and other life’s misfortunes is personal responsibility and charity. I disagree. It’s hard to be personally responsible if you’ve been a victim of forces beyond your control: mental disability for example as is the case with many homeless, or mass layoffs. The problem with charity is that it’s selective and whimsy. While there’s no shortage of charity causes here in New York City, the problem is that they mostly target arts, children and breast cancer. Nothing wrong with this, of course, but you can see how many other areas worthy of charity get omitted because, let’s face it, some of them are not picture perfect. And in a bad bonus year even those “New Yorkers for Children” (my favorite moniker on emotionally manipulative scale, to be surpassed only by “New Yorkers for Puppies”) charities will take a back seat to personal priorities of an otherwise generous and vain Wall Street soul. As for the unemployed, I have yet to hear any conservative to explain what is exactly wrong with government hiring those people for useful projects? Because government is evil?
But we’re way past worrying about the homeless problem. At this stage we need a charity ball for the middle class. I’m afraid that such a task is insurmountable, even to Koch brothers and Warren Buffet combined. There’s only so many maids and drivers that they can hire.
Sometimes I think that I’m more conservative than conservatives because I prefer order to chaos, rules to anarchy, so that I don’t have to spend most of my waking hours solving logistical problems like dysfunctional or non-existent public transport, unsafe drinking water in the tap, malpracticing doctors. Which brings me to regulations.
“I can’t be bothered with that shit”. This is my favorite argument in support of regulations. Do you really want to spend valuable time experimenting in choosing the best vendor who sells the best meat, doctor who practices solid medicine, insurance provider that pays off? Especially if you work 12 hours a day? If we lived in the realm of neighborhood mom-and-pop shops (many conservatives still think that this is the world we live in), where you could just go to the other one down the street if the first one treated you unfairly then you could make that case. But unfortunately we live in towns where only 2 or 3 big vendors exist for any product. What is your recourse against, say, an insurance provider to whom you dutifully paid premiums for several years, and who refuses to pay off if an accident happens? Are you going to follow a classic conservative advice and go to another provider? No, you’re going to call your lawyer. Moreover, if you can do your own “testing” of the quality of meat, how are you going to know the promised quality of products that you have no expertise of measuring, like software, for example? Or how about products which questionable quality you can measure only after you’re no longer a consumer, like bad surgery or faulty car breaks? Or how can you be sure that the guy managing your 401(k) is not a crook? Do you want to spend months doing research, aside from your main job, making sure that the guy you’re entrusting your money to is not the next Madoff? And more importantly, who’s going to enforce business contracts that you enter into? Who is going to help you collect? Nicky Santoro?
Sports have strict rules. That doesn’t keep athletes and teams from succeeding. In fact that makes the game more exciting because it is the ultimate ‘let the best man win’ situation. The beauty of a fair competition is that no particular party has an advantage at the beginning of the game. There are stronger teams and weaker teams, of course, but they all play by the same rules. By the same token, I do not resent the fact that there are rich and there are poor, contrary to conservatives’ cries; I resent the fact that there are different rules for different classes, that the game is rigged.
Conservative insists on being left alone, but who is should provide that aloneness, that peace of mind, that mechanism that makes trains run on time, the streets lit up at night, the garbage picked up in the morning? Hire a guy to do that for you. Let that guy have enforcement powers if someone is out to screw you. Such guy is the government, whether you like or not, whether you admit it to yourself or not.
By the way, speaking of Nicky Santoro. What can be better to conclude my post than this insightful quote from the movie, where Nicky laments on how reckless the Mafia has handled the casino business:
“But in the end, we fucked it all up. It should have been so sweet, too. But it turned out to be the last time that street guys like us were ever given anything that fuckin’ valuable again.”
In Praise of Communal Values
Competition has been shown to be useful up to a certain point and no further, but cooperation, which is the thing we must strive for today, begins where competition leaves off. Franklin Delano Roosevelt.
I’m Russian, let’s just get that out of the way. May 9th is a special day for any Russian. It’s both a joyous celebration of our victory over fascist Germany in 1945 and also a day of reflection and remembrance. To many people it’s the most treasured and most profound, a knot-in-the-throat holiday, as sacred as 4th of July is for any American. Every family has a relative who died or fought in that war. With sadness I watch more and more veterans leave our ranks every year and I contemplate over these special men and women and wonder what I would do if I was born in 1924. Would I have the guts to do what they did, to be on the frontlines, to face an armada of German tanks pacing toward me when I had just a rifle and a grenade? There’s no place of cynicism and individuality on the battlefield. My generation grew up watching war movies and talking to live witnesses of those events, we played “war” and our heroes were young partisans. We grew up picturing ourselves in those situations and admiring real war heroes, just like young Americans grow up admiring comics superheroes. During those games and those daydreams what was always present is the collective spirit. “We’ll show them!” – our thinking went. There was no “I” on our imaginary playground battlefield. Contemplating the victory in World War II (or Great Patriotic War) for a Russian is to invoke the “us” narrative.
Traders also protest free market. But from a different angle.
How about this one?
OTC trading is only good if you’re doing it. If others are doing it it’s bad!
I can’t help but quote from the article:
The protest followed a massive block options trade performed in Eurodollar futures on Thursday. Block trades are privately negotiated transactions performed off the trading floor, but cleared by the exchange, and reported minutes later on the CME website.
The locals were upset because they weren’t able to participate in the trade, brokers said.” (Emphasis mine)
The Guy Who Left Goldman Sachs
I don’t know much about Goldman personally, other than that article by Matt Taibbi and now the letter. All I know is when I was trying to short ABX (a mortgage-backed index) in early 2007 Goldman had absolutely the worst bids, meaning they didn’t want to take the other side of the trade. That spoke volumes. They had the same axe I did! More recently, at a party, a person who didn’t know that I knew he worked at Goldman said that he worked at “a hedge fund”. And it’s not like I asked.
But a few thoughts on the letter and on the reaction. Reading the reaction the first thing I thought was that even while on the buy side I didn’t have enough time to read anything unrelated to work, let alone comment on it. At Goldman, by nature of it being the sell side, I assume, people work even harder thus having no time for and no access to social sites. Which, using further deduction, means that people posting derogatory comments about the guy do not and have never worked at Goldman. And if they do now they are not Goldman material and should be fired.
Furthermore, some commenters are upset that he slammed the door on the company that nurtured him, others are upset that his epiphany came a little too late. Some say that he was a nobody, a low-level employee, but the others say that it’s nice to slam the door when you’ve got enough money to never have to work again. So which is it? He cannot be all of the above. Frankly, I don’t think that a VP, even at Goldman, even after 12 years has enough to retire. So kudos to him there.
On the other hand it’s hard to ignore the nature of his disappointment. Goldman is in the business of making money, not saving the world. The daily routine for an average Wall Street worker is dull and unrewarding but it pays well. Perhaps, with his skills he would be better suited working for World Bank or the UN. To be well paid and receive satisfaction from your job – well, that’s too much to ask for these days. It’s either or. But he wanted both.
I saw some of those “Muppets” at the industry conferences – guys from pension funds and German banks. It’s not an inaccurate description at all. They wanted yield and they didn’t care how they got it. So Goldman and other banks provided. KYC (know you client) they did. If they didn’t give the client what he wanted he would have gone to another dealer – an anathema to any banker worth his keep! And it wasn’t illegal, and those were qualified institutional investors! And if they weren’t – it wasn’t Goldman’s fault. I’m not defending Goldman at all, I’m just describing a part of the larger environment that got the snowball rolling. Inept investors with billions to invest, smart Goldman bankers – it’s like two naked people in bed – what do you think was gonna happen?
Wall Street, as described in detail in many of my earlier posts, is a close-knit community with us vs. them mentality. Even more pronounced at Goldman I would think. Everybody outside is a loser, a non-entity. Greg Smith is outside now. I understand that Goldman as a company is not pleased with whistleblower like him. But I don’t understand why laymen are angry at the guy. I think what he did is a good exercise of free will – leaving Goldman with a slam of the door. He may be mistaken about some things but he’s not without balls.
The Spell of Wall Street
“Seek first to understand then be understood.” Anonymous.
Understanding Wall Street mentality is a bit like understanding military mentality. There’s something utterly profound when brothers in arms pull together in the heat of battle and persevere. Wall Street fancies itself to be like the military. The place is rich soil for military quotes and references and “war stories”. Making money in adverse conditions is viewed as an act of valor, a display of incredible courage. Many in a decision-making position have “killed” or “been killed” at least once. Continue reading
Honest Conservatives
It is possible, although decreasingly so in American politics, to admire, if disagree with, your political opponents. I keep a dwindling collection of conservatives, who are not preoccupied with vengeance, destruction, pledges and sexual politics. I call them thinking conservatives and perhaps the matters where we disagree would come down to economics and foreign policy. David Frum is on that list, so is David Brooks. William Buckley, the lucid founder of conservative magazine National Review, whose son Christopher Buckley famously left his father’s venue and voted for Obama in 2008, was a pleasure to read before he passed away, if not for agreement but for his deft command of English. I can hardly imagine a current day conservative to publicly criticize Ayn Rand, as well as denounce John Birch Society as “far removed from common sense”. Who does the Right have now to carry the torch – Rush Limbaugh? Charles Krauthammer? It’s beyond embarrassing! Continue reading
Left with Balls 