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At least for a while this is likely to be the final word on The Rock.
It’s in today’s Alex.
Oh, and thanks to Johan Steunenberg at Calculated Risk for pointing out this one – Credit Suisse looks like they have their own “rogue traders”. If you don’t read German (and mine is not the best, so apologies If I have misunderstood) Johan is speculating that CS may have taken a cue from a previous Alex (mentioned below) and found some rogue traders to cover up sub-prime losses.
That would be false reporting, wouldn’t it? Anyway, It looks like a story worth following.
I can only note with sadness the nationalisation of Northern Rock – an outcome I regarded as fairly well inevitable due to the desperately botched process from the original announcement of problems (not even made by Northern Rock itself) through to the guarantee and on to the sale process.
As I said earlier – this should be an object lesson to governments not to get involved. I would also add to that and say that there are a lot of takeaways from this for banks – get the name risk procedures in place early and practice them often. Treat liquidity risk as, if anything, more important than credit risk. On a more personal note – make sure your risk management people are amongst your best. Pay them well.
I was re-reading last week’s The Economist last night when I happened across the Buttonwood column that I had missed on my first pass. The title, “Heart of Glass” was not promising, but the tagline was very interesting – “Existing regulation seems to encourage banks to get into trouble“.
Buttonwood makes the very valid point that, despite often being derided as the “Wild West” operators, the hedge funds have come through all this (so far at least) without too many major losses. Only a very few have failed (I can think of only one so far, although I am sure there are more) and there have not been many major losses announced.
Banks, on the other hand, have not had a good record. Apart from actually being behind much of the lending that actually caused the issues in the first place the big losses also seem to be concentrated there – just not in the banks that originated the loans. The question Buttonwood asks, but ultimately shies away from is this – is this despite, or because of, the regulations?
Buttonwood puts it this way:
This suggests two main possibilities. Either the standard of bank regulation is very poor or there is something about being regulated that leads to trouble.
The answer from Buttonwood is that it is both – but clearly puts more weight on the first. I would, respectfully, disagree on where the weight should lie.
There are many faults with bank regulation around the world – Basel
I, for example, I regard as having improved matters to the extent it was
global, but made matters worse by its reliance on simple rules – for
example that a loan secured on residential real estate shall attract a
50% weight – regardless as to whether it was super-prime, prime or
sub-prime. It also created strong incentives to “game” the system by the
“originate and distribute” model that really gave rise to
securitisations. This gave a logical reason why a bank may choose to
eliminate assets from its balance sheet (other than the possibility they
were bad assets) and the market for these assets grew – and ultimately
the market got fed some rubbish oops, I mean high-yield assets.
Basel II,
particularly the Advanced methodologies, is much better in that economic
capital is much closer to regulatory capital – a point I have made many
times. It is, however, nearly impossible for smaller banks to implement
and most regulators have also said that, to an extent at least, Basel I will effectively continue to apply for a while through the capital flaws floors.
The incentive to game the system, then, will continue, particularly for the banks going Standardised. There are also many other examples of regulations that, while possibly carefully thought out, end up causing many more problems than the one they were originally designed to stop (submissions invited in comments).
Buttonwood’s proposed solution is, essentially, to re-introduce the US Glass-Steagal Act of 1933, essentially separating commercial banks (that interact with the general public) and investment banks (that do not). The commercial banks would attract a government guarantee and the investment banks would be free to fail. Entities like Citigroup would have to break themselves into two.
In the (probably too many) years I have been dealing with bank regulation I have seen it fall into several categories – ranging from the ones that simply mandate what would otherwise be common sense to the merely annoying to the outright catastrophic. The last ones tend to be introduced and then pulled pretty quickly.
Some of it is needed for legal or criminal purposes – AML/CTF falls into this category. For the rest I would like, as I have said earlier, to see the regulation substantially removed (or at least pared back) and solutions other than a single monolithic regulator for each country to be tried. If a single regulator gets it wrong now the whole system is at risk until the government rides in on its White Charger – see Northern Rock. A truly competitive system would not allow a single regulator to have that much downside on its failure.
The news that SocGen is going out to market with a request for more funds from its shareholders* reminded me of an Alex cartoon from a few days ago.
For obvious copyright reasons I can’t (or at least shouldn’t) include it here, so follow the link. Maybe a few more “rogue traders” will be found once this possibility strikes home.
BTW – Alex is one of the most consistently on the mark cartoons about banking, a subject that normally does not get much in the way of comic exposure. I would recommend a daily dose.
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*wot – can’t tempt a sovereign investment fund?
Interesting article (possibly behind the paywall) in Friday’s the Economist on the causes of the lax lending standards that have subsequently blown up. It points to some research by Atif Mian and Amir Sufi of the University of Chicago’s graduate school of business which points the finger directly (and unsurprisingly) at the process of securitisation, where the loan assets were parcelled up and sold off with little or no residual risk being held by the originator of the mortgage (i.e. the lender).
While this is the consensus on why this happened, the evidence presented is useful and should allow for these deals to be better structured in the future – with a fair amount of the residual risk retained by the actual lender.
Perhaps the first question that purchasers of such instruments should ask in the future is how much of the risk is with the originating lender – and do not touch it if the answer is either “not much” or “none”. The actual lender should be in the first loss (or “equity”) position for a reasonable amount.
The speech given yesterday by the Archbishop of Canterbury is interesting – to say the least. He goes in great depth into many of the issues confronted by those trying to give some effect to Sharia in Western jurisdictions. For those interested in the area a close read is worthwhile. While his focus, given his background, is on family and allied areas of law, he does touch on other issues.
This blog’s focus is on financial matters I would be interested in feedback on the questions of what real impediments are there in Western (and in particular Australian) law to allowing Sharia to govern financial arrangements? Given there is wide freedom of contract (within the regulatory limits) I am not aware of many contractual problems – provided the parties to a contract agree to the terms then generally the courts here will enforce it – regardless of whether it is founded on Sharia or not.
Regulatory and taxation issues seem to be the big ones – the banking regulatory system as it stands essentially does not cope with many Sharia compliant frameworks.
A good example of this is a Sharia compliant mortgage institution, which would not be allowed to treat its mortgages in the same way as interest bearing ones and would be effectively penalised with a much heavier capital load. This can be fixed, though – the IFSB regulatory framework could be allowed in the same way that the Basel II one has been.
Insurance would be another regulatory issue. A Takaful structure is also not coped with under current APRA standards – but there is no reason why they cannot be. In theory at least, because a Takaful insurance structure is truly mutual it should be less likely to fall over that a traditional Western insurer.
Funds management and superannuation I have dealt with previously, but as these can be dealt with under the “ethical” banner these should be the least trouble of all.
Taxation is an issue. Like the UK, the tax law is not set up here for many of the Sharia structures – with the bond-like instruments a particular example. Again, like the regulatory issues, and like the UK, these could be dealt with through fairly simple legislative changes.
Media release, requirements and forms relating to the Basel II reporting requirements were today released by APRA – only half way through the period for which the reporting will be needed. Good timing. Maybe the next changes will be released before we have to comply with them. I don’t ask for much.
By the way, there is a slightly misleading title to this piece, as the standards released today are plainly not final. In the response to submissions paper APRA moot two further changes, both to undo changes that have been made to this version. These are covered below.
One other little gripe – I had some trouble finding the response to submissions paper on the Basel II home page at APRA, as, silly me, I was looking for a paper released in 2008. Perhaps in a cunning plan to make it look like they were early, the release date on the page is 6 February 2007, not 2008. I trust this will be fixed shortly. If you are with APRA, you may want to talk to your web people and get his fixed, pronto. On the other hand, maybe not.
OK, onto the actual content. I will use the APRA paragraph numbers from the response paper to talk through them. If you are really interested, print the thing out. Double sided, it is only 7 pieces of paper. Don’t ever print all the requirements. Read the rest of this entry »
The report from the French Justice Ministry came out last night (our time). My French is less than perfect and certainly not up to the job of translating what is a torturous navigation around a legal minefield, so I have been reviewing the published articles on it.
The best I have found is, as usual, from the FT. I would encourage a read if you are interested in the this whole sorry saga. The best quote, though, came from the press conference:
“Very clearly some internal control procedures didn’t work” Christine Lagarde, French Finance Minister, a quote that clearly falls into the “No S***!” category.
As almost always happens with frauds on this scale, some warnings were ignored. The French market authorities did warn SocGen on some unusual positions being taken and the French banking authorities did notice control weaknesses in their surveillance as part of the Basel II process.
Of course, for both of these the bank may have thought it was OK in ignoring them. The warnings from the markets may have only triggered a quick internal probe that identified apparently balancing trades on other markets or internally – precisely the types of arbitrage activities he was meant to be doing. Regulatory visits (I can say from experience) always identify internal control weaknesses no matter how good controls are. Regulators are also typically not as experienced in the markets as your own middle office, so bank management tend to either ignore or patronise regulatory reports.
The quick report that has been released, though, can’t be the final word. In a way, I just hope he does not plead guilty so that the whole thing comes out in court. That promises to be fascinating.
The attached document was sent to be by a friend who got it from a friend…
It seems to be an internal SocGen document on the problems encountered, and puts the chronology of events well from the Bank’s point of view. It closely mirrors the BBC’s version of events, but contradicts Kerviel’s, who insists the bank must have known he was trading outside limits long ago.
There are a few bits it does add, including (again, from the Bank’s perspective) how he got around the internal controls.
Personally, at least some of this does not wash. The margining of those (cash flows resulting from) positions over the period he had them should have been noticed, with the cash flows always needing to be much larger than his apparent position. I suppose it will all come out in the wash – it is just as well it was a larger bank with more capital than Barings was.
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