Tag Archives: Lehman Brothers

How Much Trouble Could Big Banks Be In? Lots!

The future of the Euro and the Eurozone is bleak and will likely look like a series of prolonged, rolling crises that slowly evolve to reveal just how critically the financial health of each country is affected by their individual sovereign debt and their failing banks.

The inevitable result will be severe Eurozone-wide stress, emergency liquidity loans from the IMF and the European Central Bank and politicians from all the countries involved increasingly attacking each other  over allegations of blame and corruption. To no good end.

Even the optimists now say openly that Europe will only solve its problems when there are no options left and time has run out. Less optimistic analysts increasingly think that the Eurozone will break up because all the proposed solutions are essentially Pollyannaish jokes. Let’s say the realists are right, and Europe starts to dissolve. Markets, investors, regulators and governments can stop worrying about interest-rate and credit risk, and start worrying about dissolution risk.

More importantly, they need to start worrying seriously about what the repricing of risk will do to the world’s thinly capitalized and highly leveraged megabanks. European officials, strangely, appear not to have thought about this at all; the Group of 20 meeting last week seemed to communicate a weird form of complacency and calm.

So, for all of the European officials and the U.S. bankers, here’s what dissolution risk means:  If you have a contract that requires you to be paid in euros and the euro no longer exists, what you will receive is not real clear. See? That’s dissolution risk.

Let’s say you have lent 1 million euros to a German bank, payable three months from now. If the euro suddenly ceases to exist and all countries revert to their original currencies, then you would probably receive payment in deutsche marks. You might be fine with this — and congratulate yourself on not lending to an Italian bank, which is now paying off in lira.

But what would the exchange rate be between new deutsche marks and euros? How would this affect the purchasing power of the loan repayment? More worrisome, what if Germany has gone back on the deutsche mark but the euro still exists — issued by more inflation-inclined countries? Presumably you would be offered payment in the rapidly depreciating euro. If you contested such a repayment, the litigation could drag on for years.

What if you lent to that German bank not in Frankfurt but in London? Would it matter if you lent to a branch (part of the parent) or a subsidiary (more clearly a British legal entity)? How would the British courts assess your claim to be repaid in relatively appreciated deutsche marks, rather than ever-less- appealing euros? With the euro depreciating further, should you wait to see what the courts decide? Or should you settle quickly in hope of recovering half of what you originally expected?

What if you lent to the German bank in New York, but the transaction was run through an offshore subsidiary, for example in the Cayman Islands? Global banks are extremely complex in terms of the legal entities that overlap with business units. Do you really know which legal jurisdiction would cover all aspects of your transaction in the currency formerly known as the euro?

Moving from relatively simple contracts to the complex world of derivatives, what would happen to the huge euro-denominated interest-rate swap market if euro dissolution is a real possibility? Guess what? No one really knows.

But, what I am really talking about here is the balance sheets of the really big banks. For example, in recently released filings with banking regulators, JPMorgan Chase & Co. revealed that $50 billion in losses could hypothetically bring down the bank. JPMorgan’s total balance sheet is valued, under U.S. accounting standards, at about $2.3 trillion. But U.S. rules allow a more generous netting of derivatives — offsetting long with short positions between the same counterparties — than European banks are allowed. HA!

The problem is that the netting effect can be overstated because derivatives contracts often don’t offset each other precisely. Worse, when traders smell trouble at a bank that has taken on too much risk, they tend to close out their derivatives positions quickly, leaving supposedly netted contracts exposed. Remember the final days of Lehman Brothers?

When one bank defaults and its derivatives counterpart does not, the failing bank must pay many contracts at once. The counterpart, however, wouldn’t provide a matching acceleration in its payments, which would be owed under the originally agreed schedule. This discrepancy could cause a “run” on a highly leveraged bank as counterparties attempt to close out positions with suspect banks while they can. The point is that the netting shown on a bank balance sheet can paper over this dynamic. And that means that JPMorgan’s regulatory filings vastly understate the potential danger.

JPMorgan’s balance sheet, using the European method isn’t $2.3 trillion, but closer to $4 trillion. That would make it the largest bank in the world. Holy Moly!

What are the odds that JPMorgan would lose no more than $50 billion on assets of $4 trillion, much of which is complex derivatives, in a euro-area breakup, an event that would easily be the biggest financial crisis in world history? Slim. And, None.

No one on these shores seems to see the storm coming. In an effort to forestall the impending global crisis, the Federal Reserve should be insisting that big U.S. banks increase their capital levels by suspending dividends, and set up emergency liquidity facilities with an emergency and across-the-board suspension of dividend payments, but it won’t. The Fed is convinced that its recent stress tests show U.S. banks have enough capital even though these tests didn’t model serious euro dissolution risk and the effect on global derivatives markets.

The Fed is dead wrong about that, and the pending Euro-crisis is very real. Our mega-banks are in no position to weather even the known storm, let alone the real storm when all the European counter-parties pony up to the bar with their real exposures, and the true sovereign debt gets exposed. Then, what do you think that means for smaller banks? 

How do you think that might affect the U.S. economic recovery? What is gold trading at? $1,575 an ounce?  Hmmmm.

Advertisements

Czech’s Say, “No Thanks!”

In my earlier post this morning, I focused on the ridiculous European Commission proposal for regulators and a European banking union. Here’s what the Czechs think about that:

The Czechs, who have been highly Eurosceptic, have absolutely no plans to join the euro zone, and have a healthy banking sector, have long opposed moves to centralize banking oversight.

The Daily Hospodarske Noviny (the Czech version of the New York Times) quoted Prime Minister Petr Necas today, as saying that regulation should be kept on a national basis. “We are convinced that the very high quality supervision by the Czech National Bank should not be diluted into some pan-European supervision,” Necas said.

Czech central bank Vice Governor Vladimir Tomsik said he was against raising moral hazard in the banking sector and creating a mismatch between national responsibilities of regulators while their authority would be moved to a European level.

“And the third pillar, a pan-European deposit insurance fund: I believe that is also unacceptable, because it is not possible for other countries to pay for mistakes of individual banks or supervisors,” he said in a transcript of a television interview posted on the central bank’s website http://www.cnb.cz.

And, as we mentioned in that earlier post, the UK is violently against any such proposal. British finance minister George Osborne said today that London will want to ensure safeguards are in place to protect its financial sector if the euro zone moves towards establishing a banking union.

“There is no way that Britain is going to be part of any euro zone banking union,” Osborne said in a radio interview.

So, now we have two Eurozone participants, Germany and England, making it crystal clear that they oppose any such move, and are joined by a conservative, non-Eurozone member with a healthy banking sector, who will also be severely impacted by frivolous proposals like this one.

Who are these guys and why are they allowed to speak in public?

While it is difficult for America to step into this mess, the situation in Europe is crying out for an intervention. Bernanke, Geithner and Obama have a herculean task on their hands just wrestling the U.S. economy back into grow mode with no assistance from U.S. banks, but they really need to get involved and act before the whole union catches fire.

The potential impact of a European banking collapse goes way beyond the $39 billion exposure our U.S. banks maintain. The end-result will be chaos that will drive the entire global banking community to freeze credit of all kinds, including government and corporate bonds, the last bastion of conservative investment safety.

Either the Fed and the Administration agree that Europe can be solved by a huge stimulus influx that will be sourced in a coordinated and equal effort by the U.S., Germany, China, Korea, Japan, Middle East, The UK and the rest of Europe, both in and out of the union, or agree to let it fail and accept the global consequences. This is a lot larger problem than Lehman Brothers. Maybe we need to bring Paulsen back. He was so good at bad news.

In the very short (weeks) meantime, the Fed needs to bully/scare lawmakers into actually doing something helpful. In other words, Bernanke needs to continue pressuring Congress to act now instead of bringing the economy to a so-called fiscal cliff at the end of the year where several tax cuts could expire and the debt ceiling may need to be raised again.

If I were Bernanke, I would be yelling at Congress to do something right with fiscal policy. There can’t be any more uncertainty about the fiscal cliff at the end of the year. Democrats and Republicans have to stop playing politics and actually turn into statesmen.

The European Union itself is clearly doomed. I am starting to worry about the U.S. union as well.


European Commission Rearranges Deck Chairs As Europe Burns.

The European Commission proposed what has been characterized as far-reaching powers for regulators to deal with failing banks on Wednesday.

Is this a chilling picture? This tepid proposal, which recommends closer coordination between countries and increased powers to force losses onto bondholders, won’t take effect before 2014, which will be way too late for Greece and Spain, which appears on the brink of being forced to seek a Greek-style bailout, as it is obviously unable to refinance its indebted lenders.

Even if Europe were not on fire at the moment, there are a ton of hurdles to the banking union championed by ECB President Mario Draghi – which is basically a three-pillar plan to establish a central monitoring of banks (gee, I thought that’s what the ECB already did), a fund to wind-down big lenders (we call that a bail-out here in the U.S.) and a pan-European deposit guarantee (good luck getting anything done “pan-European” style.)

Smartly, and true to form, Germany has balked at signing up to a single European scheme that could see it shoulder the costs of a bank collapse in another country (and, why should they?), and Britain fiercely resists any attempt by Brussels to impose EU controls over financial services, which account for almost a tenth of its Wall Street like economy.

At least there are a couple of people who have noticed that Europe is burning:

Nicolas Veron of Brussels think tank Bruegel, says “Everybody’s energy right now should be focused on the current crisis. I’m not sure we can afford the luxury of thinking about a permanent framework when the houses are burning.”

Daniel Gros of the Centre for European Policy Studies think tank said while it was in everyone’s interest to prevent a repeat of the chaos that followed the collapse of U.S. investment bank Lehman Brothers, action was needed now.

“We need immediate decisions”, he said. “We have a crisis on our hands.”

The Commission’s stupid 156-page (draft) legislation, recommends giving supervisors powers to “bail in” or force losses onto bondholders of a failing bank so that taxpayers are kept off the hook, and forge closer links between national back-up funds to wind up cross-border lenders. They can’t even move off of draft.

Are they kidding?

“There was little appetite to create pan-European funds,” he said. “There would be mistrust among states in pursuing such cooperation.”

Translation: Nothing will happen.

Berlin, recognizing the panic in the details and knowing it is firmly in the driver’s seat, is in no hurry. Germany knows that Europe will not make any final decisions on strengthening economic policy coordination between member states until at the earliest, spring of 2013.

The Centre for European Policy Studies’ Gros said only an acceleration of the crisis would prompt German Chancellor Angela Merkel into faster action.

“If it is a slow grind, where the German economy is not visibly affected, it will be hard for her to do that. It has to be so urgent that there is an emergency summit of leaders and that she returns home and says: ‘there was no choice’.”

If you knew that it would come to that, and you were Angela Merkel, what would you do?


$2 Billion? Chump Change. Jamie Dimon Has Real Problems Now.

The US Federal Reserve has just released data that shows mind-boggling trade positions that JP Morgan has taken in synthetic credit indices, an extremely haphazard class of derivative, also known as Credit Default Swaps (CDS).

Um, try $100 Billion worth; an increase from a net long notional of $10 Billion at the end of 4Q11, to $84 Billion by the end of 1Q12.

All banks are required to report quarterly on these things and JP Morgan’s position in CDS has jumped eight-fold in under 6 months. This may raise additional concerns about JP Morgan’s investment strategy in synthetic products.

In investment-grade CDS with a maturity of one-year or less, JPMorgan‘s net short position exploded  from $3.6 billion notional at the end of September 2011 to $54 billion at the end of the first quarter.

Over the same period, JPMorgan’s long position in investment grade CDS with a maturity of more than five years leapt five times from $24 billion to $102 billion (see chart). They are either really, really smart, or really, really, stupid. If it’s the latter, guess who bails them out?

“I don’t care how big a bank you are, that’s still a big move,” said one seasoned credit analyst.

JPMorgan’s chief executive Jamie Dimon said his firm began closely examining the CIO’s (Chief Investment Officer) controversial trading strategy in closer detail when large mark-to-market losses – put at $2 billion by Dimon during an analyst call on May 10 – started appearing in the second quarter.

Dimon has since tried to balance his exposures by flipping positions in long, high-yield CDS and short positions in investment-grade CDS, but the crazed selling of these CDS positions is eerily reminiscent of the final hours of Lehman Brothers.

People will question senior JP Morgan management signing off on a trading strategy that vastly increased the banks’ exposure to a worsening credit environment at a time when other banks were battening down the hatches. In dramatic contrast to JPMorgan, the Fed data show ALL other major US banks (GSax, Citi, B of A, Morgan Stanley) maintaining large short positions in investment-grade credit in expectation of a continuation of the rocky credit environment persisting throughout the second half of 2011.

The figures underscore JPMorgan’s failure to act at an earlier stage, given the large concentrations of risk it was accumulating, as well as the inability of regulators to discern abnormal trading patterns among the piles of data banks already reported to them. Shame on the SEC … again.

On the day (May 10th) that the $2 Billion loss story broke, that morning’s The Gartman Letter, market commentator Dennis Gartman wrote:

“The press conference… caught everyone a bit off guard and does raise all sorts of flags and does indeed cause us to remind ourselves that “there is never just one cockroach;”          however, if the losses sustained are held to what was reported yesterday afternoon, then we must remember that this is isolated; that it shall be a loss of only 30 cents/share; that Jamie Dimon’s pristine reputation has been irreparably sullied; that the Left shall use this as an excuse for even more onerous over-sight of the banking/broking businesses of the nation, but the nation is not in jeopardy and we shall all go on.”

IF … “the losses sustained are held to what was reported … .”.

Should be an interesting couple of weeks on Wall Street.


The Simple Way to Fix the Banks and Prevent Another Meltdown.

To paraphrase Michael Lewis, the former Salomon Bros. bond trader and author of Boomerang, Moneyball and The Big Short, break ’em up, make them small and don’t allow gamblers to give advice to investors.

Lewis famously points out in a Slate interview that future generations will look back at the crash of 2008, and wonder, “How did you not notice 24-year-olds were being paid $2 million a year who clearly didn’t know anything?” And, I would add “How did you expect to put people in a room with a machine that spun junk into gold and not expect them to use it?”

The amazing thing to me is, with all of the hand-wringing and posturing by our politicians following the crash and the subsequent bail-out, not one thing has changed. Dodd-Frank has no teeth in the areas that matter, and has yet to be implemented. I think it was actually passed way back in 2011. Glass-Steagall remains repealed, and there is no legislation in Congress which addresses any of the issues around the four provisions of the Banking Act of 1933 that limited commercial bank securities activities and affiliations between commercial banks and securities firms.

So, as best as I can tell, there is nothing to prevent Goldman or Citi or the rest from creating the equivalent of a credit default swap, taking a short position on it with its own money and peddling it to others, all the while knowing that it is made of junk. When the new credit default swap crashes and burns, its birth mother makes out like the bandits they are.

That is exactly what happened in the run-up to 2008, and when it all caught fire, we know who was left holding the bag. And, I don’t know how you feel, but I don’t want to go there again.

The simple fix is to break up the banks, making sure that none of them are large enough to hold anyone hostage again and to assure that the (Charles Schwab-like) investment advice is separated from the (Lehman Brothers-like) gamblers on the investment capital side. Make the banks go back to a wealth advisory role and make the gamblers become hedge funds. And, don’t ever hire any MBA’s under 30!

This, by the way, is the same Congress that is sitting on one of the potentially most important pieces of legislation introduced by this Congress, the Entrepreneur Access to Capital bill that seems completely stalled in the Senate. A bill that could lead to actual job growth, enormous capital  formation through a new and exciting asset class, and some rocket fuel for an economy that is already sagging (orders for durable goods fell in January by the most in three years and  the S&P/Case-Shiller index of property values in 20 cities fell 4 percent from a year earlier, reports showed yesterday).

Why is the Senate sitting on it? Because the same people who brought you the Bernie Madoff Ponzi scheme (which somehow managed to escape SEC attention even after four reviews), are concerned about protecting investors from fraud because, “There are lots of snake-oil salesmen on the Internet.” Really? You want snake-oil? Go down to lower Manhattan.

This fraud excuse is bogus for reasons other that that, however.

First, every crowdfunding site, including iSellerFINANCE, will have thoroughly vetted each offering before it gets posted to their platform, assuring that the same level of due diligence has been performed as would have been the case if a traditional Venture Capital firm had studied the deal.

Second, the various forms of the bill now in the Senate, limit (or cap) the investment at a maximum of $10,000 or 10% of an investor’s annual income. So, someone may lose $10,000. That’s a Mitt Romney bet. Not a serious amount of money for average investors. And, the upside is enormous. $10,000 invested in Amazon, Apple and Google just 8 years ago would be worth a jaw-dropping $402,452 today.

Third, the fraud excuse is really driven by the lobbyists who are working hard on behalf of, guess who? The investment banking community, who will get cut out of whatever this action might turn out to be. Surprise, surprise! And then there is the emotional reason. Somehow, these same politicians are way OK with using crowdfunding for their own campaigns, and yet there is no mechanism in place to protect investors from what happens to them when these guys get in office.

 

 

Politicians go out to thousands of supporters and say, “Hey give me as much money as you can afford (capped, of course).  Collectively it will add up to something substantive so that I can talk about my goals, build my team, market my message and get elected (or re-elected).”  Entrepreneurs do the same thing (take an idea, make a proof of concept, build a company, and hire employees to market and grow) but only with accredited investors (aka millionaires).  Here’s the ironic part.  It is legal for politicians to go to the masses and advertise, but illegal (under SEC regs) for entrepreneurs to do the same thing. And the bill, in its current form still doesn’t allow “advertising” of these crowdfunding deals. How that gets worked out is anyone’s guess.

When it comes to crowdfunding, entrepreneurs are held to a different standard than politicians. Why are there rules on how much money one has to make in order to give to an entrepreneur but there are none when it comes to politicians?  100% of Americans can give to politicians of their choice but only 5% of the wealthiest Americans can invest in entrepreneurs to create jobs.  Really? The rationale, according to the opponents to Crowdfund Investing is that Americans aren’t sophisticated enough to understand the risks inherent in investing in startups.

If they don’t think people are sophisticated enough to decide how to invest a few thousand dollars in a venture, why do they think these same people are smart enough to choose the right candidates?   Why do we allow people the freedom to use their money as they wish when it comes to crowdfunding politicians, but we don’t give them the same freedom to use their money as they wish when it comes to investing in startups and entrepreneurs?  Are we to assume that there’s no fraud in politics?  Should the supporters of Representative Weiner or presidential candidate Herman Cain get refunds?

This election season, over half a billion dollars will go to fund the campaigns of many a politician.

 

Imagine the impact we could have on our economy if that amount of money went into starting new businesses?  Businesses that create jobs; jobs that provide income; income which consumers spend with increased confidence.  Increased consumer spending further stimulates the economy. This bill will get us out of this recession. It’s time to let your Senator know how you feel. Let’s get this done!

 


25 People to Blame for the Financial Crisis. Meet #s 18, 17 and 16.


Hank Paulson

 

I am actually a huge fan of Hank Paulsen. He was a strong SecTreas before the meltdown and he got a little caught in the headlights at the end, knowing that he was out of  a job in a couple of weeks. He was put in the almost impossible position of trying to explain to the American taxpayers why $878 Billion dollars were going to go to bail out banks and insurance companies that had gambled the USA into a financial meltdown, WITHOUT any consequences because Congress, not Treasury, felt the need to knee-jerk something in place as huge Financial Institutions like Lehman were crumbling around their ankles.

When Paulson left the top job at Goldman Sachs to become Treasury Secretary in 2006, his big concern was whether he’d have an impact. He ended up almost single-handedly running the country’s economic policy for the last year of the Bush Administration. Impact? You bet. Positive? Not yet. The three main gripes against Paulson are that he was late to the party in battling the financial crisis, letting Lehman Brothers fail was a big mistake and the big bailout bill he pushed through Congress has been a wasteful mess. Only, because there were no strings attached. Not Paulsen’s problem; Congress’s problem. But, nonetheless, he is stuck with it. But, I only put him at 18th. There are far more venal culprits to come.

 

Lew Ranieri: #17.

Lew Ranieri

 

Meet the father of mortgage-backed bonds. In the late 1970s, the college dropout and Salomon trader coined the term securitization to name a tidy bit of financial alchemy in which home loans were packaged together by Wall Street firms and sold to institutional investors. In 1984 Ranieri boasted that his mortgage-trading desk “made more money than all the rest of Wall Street combined.” The good times rolled: as homeownership exploded in the early ’00s, the mortgage-bond business inflated Wall Street’s bottom line. So the firms placed even bigger bets on these securities. But when subprime borrowers started missing payments, the mortgage market stalled and bond prices collapsed. Investment banks, overexposed to the toxic assets, closed their doors. Investors lost fortunes. And here we are today. Thanks, Lew.

 

Marion and Herb Sandler

herb marion sandler

 

In the early 1980s, the Sandlers’ World Savings Bank became the first to sell a tricky home loan called the option ARM. And they pushed the mortgage, which offered several ways to back-load your loan and thereby reduce your early payments, with increasing zeal and misleading advertisements over the next two decades. The couple pocketed $2.3 billion when they sold their bank to Wachovia in 2006. But losses on World Savings’ loan portfolio led to the implosion of Wachovia, which was sold under duress late last year to Wells Fargo. And, again … I have no malice for the Sandlers … this is America with a capital A and everyone should be allowed to seek their dream and drive it to the big bank in the sky. But, just once, can we ask “Does this make sense?”, before we open the gates?