tisdag 19 maj 2009

Catastrophic to Awful! - The Banking Spin Cycle

Former banking regulator William Black described the process:
“The way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you're a Ponzi-like scheme. And the third thing you do is we call it leverage. That just means borrowing a lot of money, and the combination creates a situation where you have guaranteed record profits in the early years. That makes you rich, through the bonuses that modern executive compensation has produced. It also makes it inevitable that there's going to be a disaster down the road.”

“Geithner is covering up. Just like Paulson did before him. Geithner is publicly saying that it's going to take $2 trillion — a trillion is a thousand billion — $2 trillion taxpayer dollars to deal with this problem. But they're allowing all the banks to report that they're not only solvent, but fully capitalized. Both statements can't be true. It can't be that they need $2 trillion, because they have massive losses, and that they're fine. These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed. AIG was being used secretly to bail out favored banks like UBS and like Goldman Sachs. Secretary Paulson's firm, that he had come from being CEO. It got the largest amount of money, $12.9 billion. And they didn't want us to know that. And it was only Congressional pressure, and not Congressional pressure, by the way, on Geithner, but Congressional pressure on AIG.”

For the banks currently: "On the liability side, some things aren't right and on the asset side, nothing's left."

Amusingly, Peter Hahn, a former managing director of CitiGroup and now a fellow at London's Cass Business School, was reported by Bloomberg as saying: "When you look at the income numbers that have been put out by banks recently, they contain so much fudge and financial manipulation. You could say that the automobile industry has a clearer future at the moment."

Banks have gone from catastrophic to just awful. By most standards, that condition does not constitute a necessary and sufficient condition for a recovery in the global economy.

The Wreck of Modern Finance
In order to increase profits, traders devised more and more complex derivatives types, the management of which required dangerously false assumptions about randomness. These more complex contracts up-fronted most of their profit, leading to bonus bonanzas, while leaving their risks ticking like a time-bomb through their entire duration of several years – so we may not yet have seen all the loss explosions this business will produce.

In summary, the dangers of CDS are so out of proportion to their modest advantages as risk management tools that it seems wisest for the authorities to ban them altogether, not something I would normally recommend.

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