Secrets of Cyprus...

Just something to think about when scratching your head over the astonishing developments in Cyprus, which seem to be more or less intentionally designed to touch off bank runs in several European nations. Why? Courtesy of Zero Hedge:

...news is now coming out that the Cyprus parliament has postponed the decision and may in fact not be able to reach agreement. They may tinker with the percentages, to penalize smaller savers less (and larger savers more). However, the damage is already done. They have hit their savers with a grievous blow, and this will do irreparable harm to trust and confidence.

As well it should! In more civilized times, there was a long established precedent regarding the capital structure of a bank. Equity holders incur the first losses as they own the upside profits and capital gains. Next come unsecured creditors who are paid a higher interest rate, followed by secured bondholders who are paid a lower interest rate. Depositors are paid the lowest interest rate of all, but are assured to be made whole, even if it means every other class in the capital structure is utterly wiped out.

As caveat to the following paragraph, I acknowledge that I have not read anything definitive yet regarding bondholders. I present my assumptions (which I think are likely correct).

As with the bankruptcy of General Motors in the US, it looks like the rule of law and common sense has been recklessly set aside. The fruit from planting these bitter seeds will be harvested for many years hence. As with GM, political expediency drives pragmatic and ill-considered actions. In Cyprus, bondholders include politically connected banks and sovereign governments.  Bureaucrats decided it would be acceptable to use depositors like sacrificial lambs. The only debate at the moment seems to be how to apportion the damage amongst “rich” and “non-rich” depositors.

Also, much more on the matter here, mostly expressing similar sentiments. And do read The War On Common Sense by Tim Duy:

This weekend, European policymakers opened up a new front in their ongoing war on common sense.  The details of the Cyprus bailout included a bail-in of bank depositors, small and large alike.  As should have been expected, chaos ensued as Cypriots rushed to ATMs in a desperate attempt to withdraw their savings, the initial stages of what is likely to become a run on the nation's banks.  Shocking, I know.  Who could have predicted that the populous would react poorly to an assault on depositors?

Everyone.  Everyone would have predicted this.  Everyone except, apparently, European policymakers....
 

Strategic recklessness

Some poignant (and infuriating) insight from Chris Arnade on Why it's smart to be reckless on Wall St.:

... asymmetry in pay (money for profits, flat for losses) is the engine behind many of Wall Street’s mistakes. It rewards short-term gains without regard to long-term consequences. The results? The over-reliance on excessive leverage, banks that are loaded with opaque financial products, and trading models that are flawed. ... Regulation is largely toothless if banks and their employees have the financial incentive to be reckless.

For banks, nothing is illegal

This would be literally unbelievable, except that we've all become desensitized to the double standard of our justice system -- enforcement of laws against ordinary people, and systematic collusion with large banks and corporate offenders to keep anyone from going to jail. I think Matt Taibbi offers the most honest take on this shameful decision to slap HSBC with fines only, rather than pursuing what should have been slam-dunk prosecutions for money laundering and drug smuggling on a global scale:

Wow. So the executives who spent a decade laundering billions of dollars will have to partially defer their bonuses during the five-year deferred prosecution agreement? Are you fucking kidding me? That's the punishment? The government's negotiators couldn't hold firm on forcing HSBC officials to completely wait to receive their ill-gotten bonuses? They had to settle on making them "partially" wait? Every honest prosecutor in America has to be puking his guts out at such bargaining tactics. What was the Justice Department's opening offer – asking executives to restrict their Caribbean vacation time to nine weeks a year?

So you might ask, what's the appropriate financial penalty for a bank in HSBC's position? Exactly how much money should one extract from a firm that has been shamelessly profiting from business with criminals for years and years? Remember, we're talking about a company that has admitted to a smorgasbord of serious banking crimes. If you're the prosecutor, you've got this bank by the balls. So how much money should you take?

How about all of it? How about every last dollar the bank has made since it started its illegal activity? How about you dive into every bank account of every single executive involved in this mess and take every last bonus dollar they've ever earned? Then take their houses, their cars, the paintings they bought at Sotheby's auctions, the clothes in their closets, the loose change in the jars on their kitchen counters, every last freaking thing. Take it all and don't think twice. And then throw them in jail.

Sound harsh? It does, doesn't it? The only problem is, that's exactly what the government does just about every day to ordinary people involved in ordinary drug cases.

And people wonder why the US falls year after year a little further down the Corruption Perceptions Index? As of 2012, we're just slightly ahead of Chile, Uruguay and The Bahamas. 

What's going on in Greece

Numerian, one of the most insightful financial bloggers I know, gets to the bottom of the markets' surge in the wake of the Greek passage of the new "austerity" measures:

For now, stock markets are happy because they get their periodic injection of heroin – oops, make that “liquidity” – to keep the game going. The game is the one we have all lived through our whole lives – the one where capitalism continues to grow by taking on more and more debt, until now every country is at the point where only the government is big enough to take on the enormous amounts of new debt necessary to keep paying principal and interest on the old debt. At least some countries are: the United States, the UK, Germany, France. Greece of course lost that privilege several years ago, and now even big borrowers like Italy are allowed into the markets only for very short term maturities.

The game, in short, is about over, choking to death on too much debt, kept on a resuscitator by politicians and central bankers who know the public has no way to stop them from raising trillions of dollars or euros with new bond issues. Only the market can stop an out-of-control debtor. Greece has found that out, Italy and Spain and Portugal are close to finding that out, and the UK and the United States are on the list, being no more virtuous than the Greeks. Once the government can no longer borrow, default in some form is inevitable, and austerity follows. The Greeks have austerity handed to them by the Germans; everyone else will be able to choose their own forms of austerity, as different economic and social forces fight with each other in a country that has run out of borrowing capacity and must live off the taxes it is able to raise.

If the stock market had a long term view, it would think about these things. It would look at Greece as a combination horror story and warning sign. Instead, the stock market lives for the day only, and for now the debt binge continues, and the fix of easy credit is being pumped into the financial system once more. Let the celebrations continue.

Prosecuting Wall St.

By way of Simolean Sense:

The following is a script of "Prosecuting Wall Street" (CBS) which aired on Dec. 4, 2011. Steve Kroft is correspondent, James Jacoby, producer.

It's been three years since the financial crisis crippled the American economy, and much to the consternation of the general public and the demonstrators on Wall Street, there has not been a single prosecution of a high-ranking Wall Street executive or major financial firm even though fraud and financial misrepresentations played a significant role in the meltdown. We wanted to know why, so nine months ago we began looking for cases that might have prosecutorial merit. Tonight you'll hear about two of them. We begin with a woman named Eileen Foster, a senior executive at Countrywide Financial, one of the epicenters of the crisis.

Steve Kroft: Do you believe that there are people at Countrywide who belong behind bars?

Eileen Foster: Yes.

Kroft: Do you want to give me their names?

Foster: No.

Kroft: Would you give their names to a grand jury if you were asked?

Foster: Yes.

But Eileen Foster has never been asked - and never spoken to the Justice Department - even though she was Countrywide's executive vice president in charge of fraud investigations...

See the video and transcript here.

Central corporate control revealed by mathematics

If you haven't already heard about this new study on the network of corporate control, do have a look. The idea behind it was to use network analysis of who owns whom in the corporate world (established through stock ownership) to tease out centrality of control. New Scientist magazine offers a nice account, which starts as follows:

AS PROTESTS against financial power sweep the world this week, science may have confirmed the protesters' worst fears. An analysis of the relationships between 43,000 transnational corporations has identified a relatively small group of companies, mainly banks, with disproportionate power over the global economy.

The study's assumptions have attracted some criticism, but complex systems analysts contacted by New Scientist say it is a unique effort to untangle control in the global economy. Pushing the analysis further, they say, could help to identify ways of making global capitalism more stable.

The idea that a few bankers control a large chunk of the global economy might not seem like news to New York's Occupy Wall Street movement and protesters elsewhere (see photo). But the study, by a trio of complex systems theorists at the Swiss Federal Institute of Technology in Zurich, is the first to go beyond ideology to empirically identify such a network of power. It combines the mathematics long used to model natural systems with comprehensive corporate data to map ownership among the world's transnational corporations (TNCs).

But also have a look at the web site of the project behind the study, the European project Forecasting Financial Crises, where the authors have tried to clear up several common misinterpretations of just what the study shows.

Indeed, I know the members of this group quite well. They're great scientists and this is a beautiful piece of work. If you know a little about natural complex networks, then the structures found here actually aren't terrifically surprising. However, they are interesting, and it's very important to have the structure documented in detail. Moreover, just because the structure observed here is very common in real world complex networks doesn't mean its something that is good for society.

Hating bankers and the "Unholy Alliance" -- the long history

An excellent if brief article at Salon.com gives some useful historical context to the current animosity toward bankers -- it's nothing new. Several interesting quotes from key figures in the past:

“Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people. To destroy this invisible government, to befoul this unholy alliance between corrupt business and corrupt politics is the first task of statesmanship.”

Theodore Roosevelt, 1912

“We have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks. The Federal Reserve Board, a Government board, has cheated the Government of the United States and the people of the United States out of enough money to pay the national debt. The depredations and the iniquities of the Federal Reserve Board and the Federal Reserve banks acting together have cost this country enough money to pay the national debt several times over…

“Some people think the Federal Reserve Banks are United States Government institutions. They are not Government institutions. They are private credit monopolies, which prey upon the people of the United States for the benefit of themselves and their foreign customers, foreign and domestic speculator sand swindlers, and rich and predatory money lenders.”

Louis McFadden, chairman of the House Committee on Banking and Currency, 1932

I should have known this, but didn't -- the Federal Reserve Banks are not United States Government institutions. They are indeed owned by the private banks themselves, even though the Fed has control over taxpayer funds.This seems dubious in the extreme to me, although I'm sure there are many arguments to consider. Memory recalls reading arguments about the required independence of the central bank, but independence is of course not the same as "control by the private banks." Maybe we need to change the governance of the Fed and install some oversight with real power from a non-banking non-governmental element.

And my favourite:

“Banks are an almost irresistible attraction for that element of our society which seeks unearned money.”

FBI head J. Edgar Hoover, 1955.

In recent years, the attraction has been very strong indeed.

This is why knowing history is so important. Many battles have been fought before.

Matt Taibbi on OWS

Don't miss this post by Matt Taibbi on the Occupy Wall St. movement and its roots as an anti-corruption movement:

People aren't jealous and they don’t want privileges. They just want a level playing field, and they want Wall Street to give up its cheat codes, things like:

FREE MONEY. Ordinary people have to borrow their money at market rates. Lloyd Blankfein and Jamie Dimon get billions of dollars for free, from the Federal Reserve. They borrow at zero and lend the same money back to the government at two or three percent, a valuable public service otherwise known as "standing in the middle and taking a gigantic cut when the government decides to lend money to itself."

Or the banks borrow billions at zero and lend mortgages to us at four percent, or credit cards at twenty or twenty-five percent. This is essentially an official government license to be rich, handed out at the expense of prudent ordinary citizens, who now no longer receive much interest on their CDs or other saved income. It is virtually impossible to not make money in banking when you have unlimited access to free money, especially when the government keeps buying its own cash back from you at market rates.

Your average chimpanzee couldn't fuck up that business plan, which makes it all the more incredible that most of the too-big-to-fail banks are nonetheless still functionally insolvent, and dependent upon bailouts and phony accounting to stay above water. Where do the protesters go to sign up for their interest-free billion-dollar loans?

CREDIT AMNESTY. If you or I miss a $7 payment on a Gap card or, heaven forbid, a mortgage payment, you can forget about the great computer in the sky ever overlooking your mistake. But serial financial fuckups like Citigroup and Bank of America overextended themselves by the hundreds of billions and pumped trillions of dollars of deadly leverage into the system -- and got rewarded with things like the Temporary Liquidity Guarantee Program, an FDIC plan that allowed irresponsible banks to borrow against the government's credit rating.

This is equivalent to a trust fund teenager who trashes six consecutive off-campus apartments and gets rewarded by having Daddy co-sign his next lease. The banks needed programs like TLGP because without them, the market rightly would have started charging more to lend to these idiots. Apparently, though, we can’t trust the free market when it comes to Bank of America, Goldman, Sachs, Citigroup, etc.

In a larger sense, the TBTF banks all have the implicit guarantee of the federal government, so investors know it's relatively safe to lend to them -- which means it's now cheaper for them to borrow money than it is for, say, a responsible regional bank that didn't jack its debt-to-equity levels above 35-1 before the crash and didn't dabble in toxic mortgages. In other words, the TBTF banks got better credit for being less responsible. Click on freecreditscore.com to see if you got the same deal.

STUPIDITY INSURANCE. Defenders of the banks like to talk a lot about how we shouldn't feel sorry for people who've been foreclosed upon, because it's they're own fault for borrowing more than they can pay back, buying more house than they can afford, etc. And critics of OWS have assailed protesters for complaining about things like foreclosure by claiming these folks want “something for nothing.”

This is ironic because, as one of the Rolling Stone editors put it last week, “something for nothing is Wall Street’s official policy." In fact, getting bailed out for bad investment decisions has been de rigeur on Wall Street not just since 2008, but for decades.

Time after time, when big banks screw up and make irresponsible bets that blow up in their faces, they've scored bailouts. It doesn't matter whether it was the Mexican currency bailout of 1994 (when the state bailed out speculators who gambled on the peso) or the IMF/World Bank bailout of Russia in 1998 (a bailout of speculators in the "emerging markets") or the Long-Term Capital Management Bailout of the same year (in which the rescue of investors in a harebrained hedge-fund trading scheme was deemed a matter of international urgency by the Federal Reserve), Wall Street has long grown accustomed to getting bailed out for its mistakes.

The 2008 crash, of course, birthed a whole generation of new bailout schemes. Banks placed billions in bets with AIG and should have lost their shirts when the firm went under -- AIG went under, after all, in large part because of all the huge mortgage bets the banks laid with the firm -- but instead got the state to pony up $180 billion or so to rescue the banks from their own bad decisions.

This sort of thing seems to happen every time the banks do something dumb with their money...

 More at the link.

Studies confirm: bankers are mostly non-human at the cellular level

This is no joke. Studies show that if you examine the genetic material of your typical banker, you'll find that only about 10% of it takes human form. The other 90% is much more slimy and has been proven to be of bacterial origin. That's 9 genes out of 10: bankers are mostly bacteria. Especially Lloyd Blankfein. This is all based on detailed state-of-the-art genetic science, as you can read in this new article in Nature.

OK, I am of course joking. The science shows that we're all like this, not only the bankers. Still, the title of this post is not false. It just leaves something out. Probably not unlike the sales documentation or presentations greasing the wheels of the infamous Goldman Sachs Abacus deals.

Federal Reserve Corruption

Take a look at this on the transparency of the Federal Reserve (from Financeaddict) compared to other large nations' central banks. Then watch this, where Timothy Geithner tries very hard to slip sleazily away from any mention of the $13 Billion that went directly from AIG to politically well-connected Goldman Sachs. "Did you have conversations with the AIG counterparties?" Response -- waffle, evade, waffle, stare, mumble. After that, try to tell me that the US is not neck deep in serious political corruption.

And they wonder what Occupy Wall Street is all about!

Lobbying pays off handsomely -- visual proof

From an article in The Economist, a graph showing the performance of the "Lobbying Index" versus the S&P 500 over the past decade. The Lobbying Index being an average over the 50 most intense lobbying firms within the S&P 500. It's pretty clear that lobbying -- a rather less than honourable profession in my book -- pays off:

Of Idols and Crises

Here's a quote of the day, perhaps the best metaphor I've heard for where we are now in this financial and economic crisis, a few years downstream of the initial fractures, as authorities (and bankers) in Europe are still trying to duck necessary pain and loss through clever financial slight of hand. From novelist John Lanchester, quoted in Business & Finance:

"It's like there was a giant rumbling noise, the foundations shook, there was a crack in the altar and the golden idol fell down," he says. "And then there was a silence as they picked up the idol, polished it and put it back on the altar and now they're hoping that nobody had noticed. The fact is, we've had three or four supposedly unprecedented crises in the last couple of decades, and these events seem to be getting bigger and more frequent. That suggests to me that we really need to fix the whole architecture of world capitalism, but nothing I've heard suggests that anybody's doing that." 

Truly, nobody is doing that. For the moment, in Greece, in the US, and elsewhere, everything is patchwork, a few small repairs, even the illusion of repairs, and that's it.

Making markets (appear) safe -- through more vigorous lobbying

It's as predictable as the Sun rising not long after it sets -- financial firms rightly criticized for creating dangerous systemic risks will do what is natural to protect their turf. No, not by looking deeply at their practices and asking if they actually do create greater risk, but by hiring a slew of lobbyists and image consultants to change the debate and stop any potential regulation in its tracks. As this article in the New York Times describes, now it's the turn of the high-frequency traders to follow this time-honored path (thanks to Alex Bentley at the University of Durham, UK for pointing me to this).

I learned last year that writing about finance isn't like writing about science, which I've been doing for 15 years. Scientists get touchy if you criticize their work, but generally respond with reasons and try to convince you you're wrong. Financial firms respond with threats of lawsuits. I found this out last year when I wrote this article for Wired UK on high-frequency trading and its potential systemic perils. I sent an early draft to the then PR person for GETCO, one big HFT firm, asking for her comments and help so I didn't misrepresent anything. I often find that showing interested parties early drafts of articles gets them to voice their criticisms early, so I can take them into account in later drafts. In this case it didn't work, as the PR person didn't respond with any reasoned argument.. Instead, she went quite ballistic. Even though I hadn't criticized GETCO at all in the piece -- I merely mentioned them as HFT traders, and argued that HFT trading in general may present new kinds of systemic risks -- she threatened to get the lawyers involved if I mentioned GETCO in the article at all.

GETCO is one of the firms mentioned in the NYT article as now hiring lots of lobbyists to prevent any new legislation which might hurt their profits, to hell with the stability of markets as a whole.

To be clear, I don't think these people are evil in any sense. They're trading in a legal way, and what they do brings some clear benefits to markets -- it has lowered spreads over the past decade and has indeed made it possible for many smaller traders to compete with the larger banks. But the HFT traders ought to be honest about that fact that no one -- absolutely no one -- currently knows what kinds of new systemic risks enter a market when it becomes dominated by algorithms making thousands of trades a second. This is new territory, and human intuition just isn't up working out what is likely to happen. Paul Wilmott made this point quite eloquently in an NYT OpEd well before the Flash Crash of 6 May, 2010 proved his concerns to be valid.

Since then, as I've mentioned before, we've had lots of smaller flash crashes, and a really devastating one may strike any day and possibly bring deep damage to the larger economy. Personally, it would seem sensible to put in place a speed limit of one trade per second and be done with it. Do we really need to trade faster than that?

Stress tests?

I suspect that what goes on at the European Banking Authority is pretty much above board, in general, but still -- are the stress tests reported on here really designed to find points of potential weakness? I'm not reassured when the New York Times reports that the tests were designed in part to "restore confidence in the overall health of the European financial system." This sounds a little like a public relations angle.

Later, the article gets to the real issue: are these stress tests designed to test the banks against realistically severe scenarios, or instead to throw up some soft balls to be hit hardly so as to restore (misplaced) confidence? Kudos to the writer for including this illuminating quote:

“This year’s tests still did not include the impact of a formal debt default by a European government, which is the single greatest risk facing the European banking sector at present,” Marie Diron, an economist who advises the consulting firm Ernst & Young, wrote in a note. “The publication of these results will not assuage investors’ fears over the resilience of the E.U. banking sector,” she wrote, referring to the European Union.   

The Greek crisis made clear...

This is far and away the most clear explanation I've seen of what is happening in Greece and why it poses an existential threat to the European Union. (h/t The Agonist)