many cash-strapped western banks decided to cash in their lucrative stakes as soon as lock-ins started to expire this year

TO BE NOTED: From the FT:

"Allianz and Amex to cash in ICBC stakes

By Sundeep Tucker in Hong Kong

Published: April 26 2009 22:35 | Last updated: April 26 2009 22:35

Two more foreign investors in Chinese banks are expected to cash in lucrative stakes and raise a total of more than $2bn this week as a lock-in period ends for their holdings in Industrial and Commercial Bank of China.

Allianz, the German insurer, holds nearly 2 per cent of ICBC, while American Express, the US financial group, owns 0.4 per cent, and each is free to offload half of their holding as early as Tuesday.

Such a sale would raise a combined $2.1bn, based on the bank’s closing share price in Hong Kong on Friday.

The remaining shares can be sold in October.

People familiar with the situation expect Allianz and American Express to waste little time in selling the maximum number of shares permitted.

“The timing of any sale will of course depend on market conditions,” said one. “But don’t be surprised if it happens soon.”

The two shareholders invested in ICBC, which is now the world’s biggest bank by deposits and market capitalisation, alongside Goldman Sachs in 2006 as part of a wave of overseas investments in Chinese banks.

Goldman, which holds 4.9 per cent of the Chinese lender, some on behalf of investors, last month pledged to retain at least 80 per cent of that stake until April 2010. Its stake is worth more than $8bn at current prices.

Allianz and American Express are expected to hire investment bank Goldman Sachs to oversee any potential share sale.

In 2005 and 2006, Beijing had sought foreign capital and technical expertise to boost its then moribund banking sector and cement what was billed as the start of a “strategic” relationship.

However, in the wake of the global credit crisis, many cash-strapped western banks decided to cash in their lucrative stakes as soon as lock-ins started to expire this year.

UBS and Royal Bank of Scotland gave up their holdings in Bank of China, raising a combined $3.2bn, while Bank of America pocketed $2.8bn by selling a chunk of its stake in China Construction Bank.

Allianz and American Express said last month that they would explore all potential sale methods that would maximise value and minimise market impact “with a preference for a private sale to investors”.

Regardless of the potential stock sale, ICBC and American Express plan to expand their strategic partnership, which includes credit card products development, marketing, risk management, customer service and staff training.

ICBC has been issuing American Express-branded credit cards in China since 2004.

The raft of stock sales by overseas investors has triggered frustration in China, where senior officials have decided that any fresh foreign strategic investment in its banks will be subject to a lock-up period of at least five years.

A five-year minimum tie-in was necessary to “ensure the safety of China’s banking system”, Liu Mingkang, chairman of the China Banking Regulatory Commission, recently told a seminar in Beijing."

Other cases that resulted in big settlements involved allegations of conflicts of interest and suspicions of a Ponzi scheme

TO BE NOTED: From the NY Times:

"Last year, the Securities and Exchange Commission faced criticism that it had been lax in its duties as a financial enforcer. This year, under its new chairwoman, Mary L. Schapiro, it appears to be working to change that impression. It is picking up the pace of financial settlements.

Skip to next paragraph

The New York Times

In the first quarter of 2009, the S.E.C. reached 182 new financial settlements, according to NERA Economic Consulting. That compares with 157 in the year-ago period and 123 in the previous quarter.

The largest S.E.C. settlement, for $200 million, involved UBS, accused of facilitating tax evasion. The second largest, for $177 million, involved Halliburton and a former unit, KBR, which were accused of bribing foreign officials. (The companies also settled with the Justice Department in these cases.)

Other cases that resulted in big settlements involved allegations of conflicts of interest and suspicions of a Ponzi scheme. PHYLLIS KORKKI

Next Article in Business (16 of 24) » A version of this article appeared in print on April 26, 2009, on page BU2 of the New York edition."

many of BarCap’s (and for that matter Goldman’s rivals) have failed, merged and therefore withdrawn, or scaled back, from certain markets

TO BE NOTED: From Alphaville:

"Mystic Bob Diamond Posted by Neil Hume on Apr 16 09:15.

The ebullient BarCap boss has been looking into his crystal ball and guess what, the better than expected earnings reported by Goldman, Wells Fargo aren’t a “one-off” phenomenon.

They will be repeated, says Bob.

From Bloomberg.

“You have to look at which banks have improved their competitive position in this period, and in that regard I don’t think it’s a one-off,” Diamond, 57, said in an interview today on Bloomberg Television.

“If I step back and look at the Wells Fargo earnings and the Goldman Sachs earnings, there’s good news for the whole industry there,” Diamond said. “It has been quite a while since we’ve seen analysts talk about revenue as opposed to writedowns and balance-sheet risks.”

By that we presume Diamond means the favourable widening of bid/offer spreads in customer flow business and the fact that many of BarCap’s (and for that matter Goldman’s rivals) have failed, merged and therefore withdrawn, or scaled back, from certain markets, such as fixed income, commodities and currencies.

Of course, not everyone thinks the first quarter results we be repeated. Many in the blogsphere suspect Goldman’s first quarter results will prove to be “non-recurring” in nature because they were mainly due to the unwinding of AIG hedges.

And Wednesday’s results from UBS prove that all is still not well in the IB world.

That said, Barclays’ purchase of Lehman Brother’s North American business out of bankruptcy does look to have been well timed. It has given the bank strong positions in several markets, such as US government debt, which are pretty attractive right now.

Little wonder Diamond has this to say to Bloomberg about the Lehman deal.

“When we look back, we really have to pinch ourselves.”

So do we Bob.

Related links:
Goldman’s blowout Q1 figures - reaction - FT Alphaville
UBS not in Q1 happy bank club - FT Alphaville
On Wells Fargo and banks’ well-being - FT Alphaville

This entry was posted by Neil Hume on Thursday, April 16th, 2009 at 9:15 and is filed under Capital markets, People. Tagged with barcap, barclays, bob diamond."

These numbers as large as they are, vastly understate the problem of fraud.

TO BE NOTED: From Bill Moyers Journal:

"April 3, 2009

BILL MOYERS: Welcome to the Journal.

For months now, revelations of the wholesale greed and blatant transgressions of Wall Street have reminded us that "The Best Way to Rob a Bank Is to Own One." In fact, the man you're about to meet wrote a book with just that title. It was based upon his experience as a tough regulator during one of the darkest chapters in our financial history: the savings and loan scandal in the late 1980s.

WILLIAM K. BLACK: These numbers as large as they are, vastly understate the problem of fraud.

BILL MOYERS: Bill Black was in New York this week for a conference at the John Jay College of Criminal Justice where scholars and journalists gathered to ask the question, "How do they get away with it?" Well, no one has asked that question more often than Bill Black.

The former Director of the Institute for Fraud Prevention now teaches Economics and Law at the University of Missouri, Kansas City. During the savings and loan crisis, it was Black who accused then-house speaker Jim Wright and five US Senators, including John Glenn and John McCain, of doing favors for the S&L's in exchange for contributions and other perks. The senators got off with a slap on the wrist, but so enraged was one of those bankers, Charles Keating — after whom the senate's so-called "Keating Five" were named — he sent a memo that read, in part, "get Black — kill him dead." Metaphorically, of course. Of course.

Now Black is focused on an even greater scandal, and he spares no one — not even the President he worked hard to elect, Barack Obama. But his main targets are the Wall Street barons, heirs of an earlier generation whose scandalous rip-offs of wealth back in the 1930s earned them comparison to Al Capone and the mob, and the nickname "banksters."

Bill Black, welcome to the Journal.

WILLIAM K. BLACK: Thank you.

BILL MOYERS: I was taken with your candor at the conference here in New York to hear you say that this crisis we're going through, this economic and financial meltdown is driven by fraud. What's your definition of fraud?

WILLIAM K. BLACK: Fraud is deceit. And the essence of fraud is, "I create trust in you, and then I betray that trust, and get you to give me something of value." And as a result, there's no more effective acid against trust than fraud, especially fraud by top elites, and that's what we have.

BILL MOYERS: In your book, you make it clear that calculated dishonesty by people in charge is at the heart of most large corporate failures and scandals, including, of course, the S&L, but is that true? Is that what you're saying here, that it was in the boardrooms and the CEO offices where this fraud began?

WILLIAM K. BLACK: Absolutely.

BILL MOYERS: How did they do it? What do you mean?

WILLIAM K. BLACK: Well, 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.

BILL MOYERS: So you're suggesting, saying that CEOs of some of these banks and mortgage firms in order to increase their own personal income, deliberately set out to make bad loans?

WILLIAM K. BLACK: Yes.

BILL MOYERS: How do they get away with it? I mean, what about their own checks and balances in the company? What about their accounting divisions?

WILLIAM K. BLACK: All of those checks and balances report to the CEO, so if the CEO goes bad, all of the checks and balances are easily overcome. And the art form is not simply to defeat those internal controls, but to suborn them, to turn them into your greatest allies. And the bonus programs are exactly how you do that.

BILL MOYERS: If I wanted to go looking for the parties to this, with a good bird dog, where would you send me?

WILLIAM K. BLACK: Well, that's exactly what hasn't happened. We haven't looked, all right? The Bush Administration essentially got rid of regulation, so if nobody was looking, you were able to do this with impunity and that's exactly what happened. Where would you look? You'd look at the specialty lenders. The lenders that did almost all of their work in the sub-prime and what's called Alt-A, liars' loans.

BILL MOYERS: Yeah. Liars' loans--

WILLIAM K. BLACK: Liars' loans.

BILL MOYERS: Why did they call them liars' loans?

WILLIAM K. BLACK: Because they were liars' loans.

BILL MOYERS: And they knew it?

WILLIAM K. BLACK: They knew it. They knew that they were frauds.

WILLIAM K. BLACK: Liars' loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets.

BILL MOYERS: You think they really said that to borrowers?

WILLIAM K. BLACK: We know that they said that to borrowers. In fact, they were also called, in the trade, ninja loans.

BILL MOYERS: Ninja?

WILLIAM K. BLACK: Yeah, because no income verification, no job verification, no asset verification.

BILL MOYERS: You're talking about significant American companies.

WILLIAM K. BLACK: Huge! One company produced as many losses as the entire Savings and Loan debacle.

BILL MOYERS: Which company?

WILLIAM K. BLACK: IndyMac specialized in making liars' loans. In 2006 alone, it sold $80 billion dollars of liars' loans to other companies. $80 billion.

BILL MOYERS: And was this happening exclusively in this sub-prime mortgage business?

WILLIAM K. BLACK: No, and that's a big part of the story as well. Even prime loans began to have non-verification. Even Ronald Reagan, you know, said, "Trust, but verify." They just gutted the verification process. We know that will produce enormous fraud, under economic theory, criminology theory, and two thousand years of life experience.

BILL MOYERS: Is it possible that these complex instruments were deliberately created so swindlers could exploit them?

WILLIAM K. BLACK: Oh, absolutely. This stuff, the exotic stuff that you're talking about was created out of things like liars' loans, that were known to be extraordinarily bad. And now it was getting triple-A ratings. Now a triple-A rating is supposed to mean there is zero credit risk. So you take something that not only has significant, it has crushing risk. That's why it's toxic. And you create this fiction that it has zero risk. That itself, of course, is a fraudulent exercise. And again, there was nobody looking, during the Bush years. So finally, only a year ago, we started to have a Congressional investigation of some of these rating agencies, and it's scandalous what came out. What we know now is that the rating agencies never looked at a single loan file. When they finally did look, after the markets had completely collapsed, they found, and I'm quoting Fitch, the smallest of the rating agencies, "the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined."

BILL MOYERS: So if your assumption is correct, your evidence is sound, the bank, the lending company, created a fraud. And the ratings agency that is supposed to test the value of these assets knowingly entered into the fraud. Both parties are committing fraud by intention.

WILLIAM K. BLACK: Right, and the investment banker that — we call it pooling — puts together these bad mortgages, these liars' loans, and creates the toxic waste of these derivatives. All of them do that. And then they sell it to the world and the world just thinks because it has a triple-A rating it must actually be safe. Well, instead, there are 60 and 80 percent losses on these things, because of course they, in reality, are toxic waste.

BILL MOYERS: You're describing what Bernie Madoff did to a limited number of people. But you're saying it's systemic, a systemic Ponzi scheme.

WILLIAM K. BLACK: Oh, Bernie was a piker. He doesn't even get into the front ranks of a Ponzi scheme...

BILL MOYERS: But you're saying our system became a Ponzi scheme.

WILLIAM K. BLACK: Our system...

BILL MOYERS: Our financial system...

WILLIAM K. BLACK: Became a Ponzi scheme. Everybody was buying a pig in the poke. But they were buying a pig in the poke with a pretty pink ribbon, and the pink ribbon said, "Triple-A."

BILL MOYERS: Is there a law against liars' loans?

WILLIAM K. BLACK: Not directly, but there, of course, many laws against fraud, and liars' loans are fraudulent.

BILL MOYERS: Because...

WILLIAM K. BLACK: Because they're not going to be repaid and because they had false representations. They involve deceit, which is the essence of fraud.

BILL MOYERS: Why is it so hard to prosecute? Why hasn't anyone been brought to justice over this?

WILLIAM K. BLACK: Because they didn't even begin to investigate the major lenders until the market had actually collapsed, which is completely contrary to what we did successfully in the Savings and Loan crisis, right? Even while the institutions were reporting they were the most profitable savings and loan in America, we knew they were frauds. And we were moving to close them down. Here, the Justice Department, even though it very appropriately warned, in 2004, that there was an epidemic...

BILL MOYERS: Who did?

WILLIAM K. BLACK: The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again, as you say, this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis.

BILL MOYERS: You talk about the Bush administration. Of course, there's that famous photograph of some of the regulators in 2003, who come to a press conference with a chainsaw suggesting that they're going to slash, cut business loose from regulation, right?

WILLIAM K. BLACK: Well, they succeeded. And in that picture, by the way, the other — three of the other guys with pruning shears are the...

BILL MOYERS: That's right.

WILLIAM K. BLACK: They're the trade representatives. They're the lobbyists for the bankers. And everybody's grinning. The government's working together with the industry to destroy regulation. Well, we now know what happens when you destroy regulation. You get the biggest financial calamity of anybody under the age of 80.

BILL MOYERS: But I can point you to statements by Larry Summers, who was then Bill Clinton's Secretary of the Treasury, or the other Clinton Secretary of the Treasury, Rubin. I can point you to suspects in both parties, right?

WILLIAM K. BLACK: There were two really big things, under the Clinton administration. One, they got rid of the law that came out of the real-world disasters of the Great Depression. We learned a lot of things in the Great Depression. And one is we had to separate what's called commercial banking from investment banking. That's the Glass-Steagall law. But we thought we were much smarter, supposedly. So we got rid of that law, and that was bipartisan. And the other thing is we passed a law, because there was a very good regulator, Brooksley Born, that everybody should know about and probably doesn't. She tried to do the right thing to regulate one of these exotic derivatives that you're talking about. We call them C.D.F.S. And Summers, Rubin, and Phil Gramm came together to say not only will we block this particular regulation. We will pass a law that says you can't regulate. And it's this type of derivative that is most involved in the AIG scandal. AIG all by itself, cost the same as the entire Savings and Loan debacle.

BILL MOYERS: What did AIG contribute? What did they do wrong?

WILLIAM K. BLACK: They made bad loans. Their type of loan was to sell a guarantee, right? And they charged a lot of fees up front. So, they booked a lot of income. Paid enormous bonuses. The bonuses we're thinking about now, they're much smaller than these bonuses that were also the product of accounting fraud. And they got very, very rich. But, of course, then they had guaranteed this toxic waste. These liars' loans. Well, we've just gone through why those toxic waste, those liars' loans, are going to have enormous losses. And so, you have to pay the guarantee on those enormous losses. And you go bankrupt. Except that you don't in the modern world, because you've come to the United States, and the taxpayers play the fool. Under Secretary Geithner and under Secretary Paulson before him... we took $5 billion dollars, for example, in U.S. taxpayer money. And sent it to a huge Swiss Bank called UBS. At the same time that that bank was defrauding the taxpayers of America. And we were bringing a criminal case against them. We eventually get them to pay a $780 million fine, but wait, we gave them $5 billion. So, the taxpayers of America paid the fine of a Swiss Bank. And why are we bailing out somebody who that is defrauding us?

BILL MOYERS: And why...

WILLIAM K. BLACK: How mad is this?

BILL MOYERS: What is your explanation for why the bankers who created this mess are still calling the shots?

WILLIAM K. BLACK: Well, that, especially after what's just happened at G.M., that's... it's scandalous.

BILL MOYERS: Why are they firing the president of G.M. and not firing the head of all these banks that are involved?

WILLIAM K. BLACK: There are two reasons. One, they're much closer to the bankers. These are people from the banking industry. And they have a lot more sympathy. In fact, they're outright hostile to autoworkers, as you can see. They want to bash all of their contracts. But when they get to banking, they say, ‘contracts, sacred.' But the other element of your question is we don't want to change the bankers, because if we do, if we put honest people in, who didn't cause the problem, their first job would be to find the scope of the problem. And that would destroy the cover up.

BILL MOYERS: The cover up?

WILLIAM K. BLACK: Sure. The cover up.

BILL MOYERS: That's a serious charge.

WILLIAM K. BLACK: Of course.

BILL MOYERS: Who's covering up?

WILLIAM K. BLACK: Geithner is charging, 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 masses losses, and that they're fine.

These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because...

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: Well, Geithner has, was one of our nation's top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he's a failed legacy regulator.

BILL MOYERS: But he denies that he was a regulator. Let me show you some of his testimony before Congress. Take a look at this.

TIMOTHY GEITHNER:I've never been a regulator, for better or worse. And I think you're right to say that we have to be very skeptical that regulation can solve all of these problems. We have parts of our system that are overwhelmed by regulation.

Overwhelmed by regulation! It wasn't the absence of regulation that was the problem, it was despite the presence of regulation you've got huge risks that build up.

WILLIAM K. BLACK: Well, he may be right that he never regulated, but his job was to regulate. That was his mission statement.

BILL MOYERS: As?

WILLIAM K. BLACK: As president of the Federal Reserve Bank of New York, which is responsible for regulating most of the largest bank holding companies in America. And he's completely wrong that we had too much regulation in some of these areas. I mean, he gives no details, obviously. But that's just plain wrong.

BILL MOYERS: How is this happening? I mean why is it happening?

WILLIAM K. BLACK: Until you get the facts, it's harder to blow all this up. And, of course, the entire strategy is to keep people from getting the facts.

BILL MOYERS: What facts?

WILLIAM K. BLACK: The facts about how bad the condition of the banks is. So, as long as I keep the old CEO who caused the problems, is he going to go vigorously around finding the problems? Finding the frauds?

BILL MOYERS: You--

WILLIAM K. BLACK: Taking away people's bonuses?

BILL MOYERS: To hear you say this is unusual because you supported Barack Obama, during the campaign. But you're seeming disillusioned now.

WILLIAM K. BLACK: Well, certainly in the financial sphere, I am. I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they're refusing to obey the law.

BILL MOYERS: In other words, they could have closed these banks without nationalizing them?

WILLIAM K. BLACK: Well, you do a receivership. No one -- Ronald Reagan did receiverships. Nobody called it nationalization.

BILL MOYERS: And that's a law?

WILLIAM K. BLACK: That's the law.

BILL MOYERS: So, Paulson could have done this? Geithner could do this?

WILLIAM K. BLACK: Not could. Was mandated--

BILL MOYERS: By the law.

WILLIAM K. BLACK: By the law.

BILL MOYERS: This law, you're talking about.

WILLIAM K. BLACK: Yes.

BILL MOYERS: What the reason they give for not doing it?

WILLIAM K. BLACK: They ignore it. And nobody calls them on it.

BILL MOYERS: Well, where's Congress? Where's the press? Where--

WILLIAM K. BLACK: Well, where's the Pecora investigation?

BILL MOYERS: The what?

WILLIAM K. BLACK: The Pecora investigation. The Great Depression, we said, "Hey, we have to learn the facts. What caused this disaster, so that we can take steps, like pass the Glass-Steagall law, that will prevent future disasters?" Where's our investigation?

What would happen if after a plane crashes, we said, "Oh, we don't want to look in the past. We want to be forward looking. Many people might have been, you know, we don't want to pass blame. No. We have a nonpartisan, skilled inquiry. We spend lots of money on, get really bright people. And we find out, to the best of our ability, what caused every single major plane crash in America. And because of that, aviation has an extraordinarily good safety record. We ought to follow the same policies in the financial sphere. We have to find out what caused the disasters, or we will keep reliving them. And here, we've got a double tragedy. It isn't just that we are failing to learn from the mistakes of the past. We're failing to learn from the successes of the past.

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: In the Savings and Loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the Savings and Loan crisis, didn't matter which party was in power, the U.S. Treasury Secretary would fly over to Tokyo and tell the Japanese, "You ought to do things the way we did in the Savings and Loan crisis, because it worked really well. Instead you're covering up the bank losses, because you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn't work. You will cause your recession to continue and continue." And the Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets. And you know what? It's working just as well as it did in Japan.

BILL MOYERS: Yeah. Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration, with the banks, are engaged in a cover up to keep us from knowing what went wrong?

WILLIAM K. BLACK: Absolutely.

BILL MOYERS: You are.

WILLIAM K. BLACK: Absolutely, because they are scared to death. All right? They're scared to death of a collapse. They're afraid that if they admit the truth, that many of the large banks are insolvent. They think Americans are a bunch of cowards, and that we'll run screaming to the exits. And we won't rely on deposit insurance. And, by the way, you can rely on deposit insurance. And it's foolishness. All right? Now, it may be worse than that. You can impute more cynical motives. But I think they are sincerely just panicked about, "We just can't let the big banks fail." That's wrong.

BILL MOYERS: But what might happen, at this point, if in fact they keep from us the true health of the banks?

WILLIAM K. BLACK: Well, then the banks will, as they did in Japan, either stay enormously weak, or Treasury will be forced to increasingly absurd giveaways of taxpayer money. We've seen how horrific AIG -- and remember, they kept secrets from everyone.

BILL MOYERS: A.I.G. did?

WILLIAM K. BLACK: What we're doing with -- no, Treasury and both administrations. The Bush administration and now the Obama administration kept secret from us what was being done with AIG. 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.

Where Congress said, "We will not give you a single penny more unless we know who received the money." And, you know, when he was Treasury Secretary, Paulson created a recommendation group to tell Treasury what they ought to do with AIG. And he put Goldman Sachs on it.

BILL MOYERS: Even though Goldman Sachs had a big vested stake.

WILLIAM K. BLACK: Massive stake. And even though he had just been CEO of Goldman Sachs before becoming Treasury Secretary. Now, in most stages in American history, that would be a scandal of such proportions that he wouldn't be allowed in civilized society.

BILL MOYERS: Yeah, like a conflict of interest, it seems.

WILLIAM K. BLACK: Massive conflict of interests.

BILL MOYERS: So, how did he get away with it?

WILLIAM K. BLACK: I don't know whether we've lost our capability of outrage. Or whether the cover up has been so successful that people just don't have the facts to react to it.

BILL MOYERS: Who's going to get the facts?

WILLIAM K. BLACK: We need some chairmen or chairwomen--

BILL MOYERS: In Congress.

WILLIAM K. BLACK: --in Congress, to hold the necessary hearings. And we can blast this out. But if you leave the failed CEOs in place, it isn't just that they're terrible business people, though they are. It isn't just that they lack integrity, though they do. Because they were engaged in these frauds. But they're not going to disclose the truth about the assets.

BILL MOYERS: And we have to know that, in order to know what?

WILLIAM K. BLACK: To know everything. To know who committed the frauds. Whose bonuses we should recover. How much the assets are worth. How much they should be sold for. Is the bank insolvent, such that we should resolve it in this way? It's the predicate, right? You need to know the facts to make intelligent decisions. And they're deliberately leaving in place the people that caused the problem, because they don't want the facts. And this is not new. The Reagan Administration's central priority, at all times, during the Savings and Loan crisis, was covering up the losses.

BILL MOYERS: So, you're saying that people in power, political power, and financial power, act in concert when their own behinds are in the ringer, right?

WILLIAM K. BLACK: That's right. And it's particularly a crisis that brings this out, because then the class of the banker says, "You've got to keep the information away from the public or everything will collapse. If they understand how bad it is, they'll run for the exits."

BILL MOYERS: Yeah, and this week in New York, at this conference, you described this as more than a financial crisis. You called it a moral crisis.

WILLIAM K. BLACK: Yes.

BILL MOYERS: Why?

WILLIAM K. BLACK: Because it is a fundamental lack of integrity. But also because, if you look back at crises, an economist who is also a presidential appointee, as a regulator in the Savings and Loan industry, right here in New York, Larry White, wrote a book about the Savings and Loan crisis. And he said, you know, one of the most interesting questions is why so few people engaged in fraud? Because objectively, you could have gotten away with it. But only about ten percent of the CEOs, engaged in fraud. So, 90 percent of them were restrained by ethics and integrity. So, far more than law or by F.B.I. agents, it's our integrity that often prevents the greatest abuses. And what we had in this crisis, instead of the Savings and Loan, is the most elite institutions in America engaging or facilitating fraud.

BILL MOYERS: This wound that you say has been inflicted on American life. The loss of worker's income. And security and pensions and future happened, because of the misconduct of a relatively few, very well-heeled people, in very well-decorated corporate suites, right?

WILLIAM K. BLACK: Right.

BILL MOYERS: It was relatively a handful of people.

WILLIAM K. BLACK: And their ideologies, which swept away regulation. So, in the example, regulation means that cheaters don't prosper. So, instead of being bad for capitalism, it's what saves capitalism. "Honest purveyors prosper" is what we want. And you need regulation and law enforcement to be able to do this. The tragedy of this crisis is it didn't need to happen at all.

BILL MOYERS: When you wake in the middle of the night, thinking about your work, what do you make of that? What do you tell yourself?

WILLIAM K. BLACK: There's a saying that we took great comfort in. It's actually by the Dutch, who were fighting this impossible war for independence against what was then the most powerful nation in the world, Spain. And their motto was, "It is not necessary to hope in order to persevere."

Now, going forward, get rid of the people that have caused the problems. That's a pretty straightforward thing, as well. Why would we keep CEOs and CFOs and other senior officers, that caused the problems? That's facially nuts. That's our current system.

So stop that current system. We're hiding the losses, instead of trying to find out the real losses. Stop that, because you need good information to make good decisions, right? Follow what works instead of what's failed. Start appointing people who have records of success, instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today, as late as it is. Even though they've had a terrible start to the administration. They could change, and they could change within weeks. And by the way, the folks who are the better regulators, they paid their taxes. So, you can get them through the vetting process a lot quicker.

BILL MOYERS: William Black, thank you very much for being with me on the Journal.

WILLIAM K. BLACK: Thank you so much."

Foreign investors in Chinese banks will in future be forced to accept a lock-up period of at least five years

TO BE NOTED: From the FT:

"China extends banks lock-up

By Jamil Anderlini in Beijing

Published: April 1 2009 18:40 | Last updated: April 1 2009 18:40

Foreign investors in Chinese banks will in future be forced to accept a lock-up period of at least five years, China’s top banking regulator said, after a series of share sales by US and European financial institutions.

In recent months, companies such as Bank of America, UBS and Royal Bank of Scotland have sold down all or part of their stakes in China’s largest state-owned banks immediately after lock-up periods of three years expired.

The new five-year minimum lock-up was necessary to “ensure the safety of China’s banking system”, Liu Mingkang, chairman of the China Banking Regulatory Commission, told a seminar in Beijing, according to people familiar with the matter and also state media reports.

Mr Liu also said Beijing would not reconsider current ownership limits for Chinese banks, which restrict single foreign investors to a 20 per cent holding and all foreign investors to no more than a combined 25 per cent stake in any Chinese bank.

The Chinese regulator decided last year not to allow a higher level of foreign involvement in domestic institutions.

That decision had not been publicly acknowledged until now and could affect the strategy of the few foreign banks that still have the ability and appetite to expand their presence in China.

HSBC, for example, bought 19.9 per cent of China’s Bank of Communications in 2004 in an agreement that would allow it to raise its stake to 40 per cent if and when the government was to raise foreign investment limits.

BofA, RBS, Goldman Sachs, Germany’s Allianz, Singapore’s Temasek and others bought shares in China Construction Bank, Bank of China and Industrial and Commercial Bank of China with promises they would help to improve the Chinese banks’ risk management and managerial capabilities.

But apart from a few minor initiatives, the partnerships largely failed to produce tangible results and when three-year lock-up periods started to expire in recent months most of these “strategic” investors sold all or part of their holdings at a profit at a time when most global banking institutions were in dire need of fresh capital.

Only Goldman has made a public commitment to hold the majority of its stake in ICBC for at least another year.

Temasek, Singapore’s state investment agency that has stakes in both BoC and CCB, has made private commitments not to dump its shares in the market, according to Chinese banking executives."

collecting deposits and turning those into low-risk loans, for consumers who usually also used the group for their grocery shopping

TO BE NOTED: From the FT:

"Banking success amid the baked beans

By Gillian Tett

Published: March 30 2009 20:42 | Last updated: March 30 2009 20:42

Three years ago, Migros bank – the financial arm of the doughty Swiss supermarket chain – seemed stubbornly unfashionable.

The bank did not pay its top bankers bonuses. Nor did it engage in risky international investments. Instead, it focused on collecting deposits and turning those into low-risk loans, for consumers who usually also used the group for their grocery shopping.

These days, however, Migros’ banking style has become all the rage. Last year, its retail deposits surged SFr2.6bn to about SFr24bn, even as customers pulled money from better-known Swiss lenders such as UBS.

That has turned Migros into one of the fastest growing private sector banks in Switzerland, if not Europe (excluding those that are partly owned or guaranteed by the state). Not bad for a brand that sprang to life selling “basics” such as noodles and soap.

There is a bigger moral here – not just for Tesco (which is planning to expand its own in-store banks), but investors and policymakers too. During the past few years, global policymakers have scrambled to find ways to rid western banks of their rotten assets, in the hope that if these existing banks could be “cleansed” they would feel confident to lend.

Yet most of those detoxifying efforts have failed: mainstream banks are still distrusted by consumers and investors and also reluctant to lend.

Consequently, as the crisis drags on, a new idea is surfacing in financial circles: namely that it could be time to start focusing on “greenfield” banks.

For the extent of toxic assets remains so large that it will be hard to revive the polluted, legacy groups soon. Thus the real hope for banking – or so this argument goes – lies with new entities or existing, untainted, institutions that are not perceived as legacy banks.

Migros is a case in point. Its managers say that one reason they are attracting so many deposits is that customers trust their low-key homespun style more than that of international groups. No doubt consumers also like the fact that Migros – unlike most of its competitors – has not needed to tap the state for help.

Another factor helping Migros – and Tesco – is that consumers also trust retailers more than banks. After all, selling baked beans is a useful and tangible business that anyone can understand. The same cannot be said for, say, trading in collateralised debt obligations.

However, retailers are not the only beneficiaries. NIBC, the Dutch bank owned by the JC Flowers private equity group, for example, launched an online retail banking business last year – and has attracted €1.5bn in deposits, by virtue of being new. That has consequently prompted the JC Flowers group to start searching for other “greenfield” banking opportunities – alongside its strategy of buying up distressed legacy groups.

Other financiers are probably doing the same. After all, the more that existing banks are forced to reduce their assets – and the more that central banks cut rates – the better banking margins should become, at least for the survivors.

No wonder Tesco has a hungry look in its eye; if nothing else, the tale illustrates that the competition instinctive remains alive in finance – even if it is now repackaged, amid soap and beans.

gillian.tett@ft.com"

Citigroup insists that its Asian business is critical to the company’s overall health

TO BE NOTED: From the FT:

"Asian challenge for western banks

By Sundeep Tucker

Published: March 22 2009 22:30 | Last updated: March 23 2009 03:08

How much will stricken western banks, now answerable to domestic taxpayers, be able to continue flexing their muscles in Asia?

The question is being raised across the region, still a relative bright spot, as aggressive competitors try to pinch market share from rivals that have traditionally used balance-sheet strength to expand lending or to provide investment banking services.

The likes of Citigroup and Royal Bank of Scotland in commercial banking, and Merrill Lynch and UBS in investment banking, have consistently been among the region’s strongest operators.

However, Citigroup, UBS and RBS have each recently received unprecedented levels of financial support from the US, Swiss and UK governments respectively. Merrill Lynch has been taken over by Bank of America, itself now shored up by the US taxpayer.

The financial woes of the affected banks have played into the hands of rivals, which are questioning their ability to lend to companies and to underwrite equity and debt offerings.

Among those in relatively better financial health are banks with large retail deposit bases, including Australia’s leading banks and the likes of Standard Chartered and HSBC.

Domestic players in countries such as South Korea and India are also seeking to profit from the decision by stricken banks to curtail lending in some markets.

“There is no way the likes of Citigroup and RBS can continue to lend in Asia in the fashion that they were doing,” says a senior executive at a well-capitalised western bank.

“We are seeing a rise in business because of this.”

However, banks such as Citigroup and RBS are fighting hard to retain market share and claim that they are refocusing Asian operations on more profitable clients and products.

RBS is withdrawing from retail and commercial banking in Asia Pacific, and plans to scale back its wholesale banking footprint to the region’s largest financial centres.

In an interview with the Financial Times while on an Asian tour last week, Sir Philip Hampton, RBS chairman, insisted that the bank remained committed to wholesale banking in the region, and pledged that its 800 core clients “will have access to a substantial balance sheet”.

Sir Philip added: “We are now strongly capitalised and have a strategy to remain in core markets where we have a competitive advantage. A key part of that is Asia Pacific.”

He said continuing to serve clients in the region would generate value for the UK taxpayer.,

Asian central banks hold about 75 per cent of the world’s currency reserves, and Sir Philip said that RBS would continue to help manage them, for instance by trading US Treasuries.

Likewise, Citigroup insists that its Asian business is critical to the company’s overall health, not least because it had to support multinational clients that plan to invest in the region.

“We continue to commit capital to key clients and are also helping them to access the capital markets,” said Farhan Faruqui, head of global banking for Citigroup in Asia Pacific. The bank has this year advised on the largest Hong Kong initial public offering as well as several large rights issues and corporate bonds.

Tellingly, the latest Dealogic investment banking revenues tables are still for 2009, comprising loans, equity and debt offerings and merger advisory services, are dominated by UBS, BofA/Merrill and Citigroup.

However, analysts believe that the real test for the stricken banks will come in the next few years and that the success of their Asian footprint will depend on their ability to retain key staff and government support for lending policies.

Copyright The Financial Times Limited 2009"

U.S. hedge funds are buying more of the nation’s stocks than they’re selling for the first time since October

TO BE NOTED: From Bloomberg:

Hedge Funds Buy Stocks for First Time Since October (Update1)

Share | Email | Print | A A A

By Elizabeth Stanton

March 19 (Bloomberg) -- U.S. hedge funds are buying more of the nation’s stocks than they’re selling for the first time since October, while mutual funds and most other investors remain net sellers, according to UBS AG.

In the four weeks ended March 13, net purchases of equities by hedge fund clients of UBS averaged $140 million, according to a March 18 report by David Bianco, the New York-based chief equity strategist at Switzerland’s biggest bank. The inflows into stocks followed 22 straight weeks of outflows.

“Those who are supposedly experts at assessing and managing risk are more confident putting capital to work than they were in October and November,” said Peter Kenny, managing director in institutional sales at Knight Equity Markets LP Jersey City, New Jersey. “That’s an indication that the market has made some constructive moves toward building a base.”

Mutual funds and other long-only investors such as pension funds and insurance companies, so-called because unlike hedge funds they don’t usually engage in short selling to bet on stock price declines, were net sellers of an average $144.8 million of U.S. shares over the same four-week period.

Net buying by hedge funds as the Standard & Poor’s 500 Index rebounded from a 12-year low on March 9 marked a change from investor behavior after stocks fell to their lowest levels of 2008 in November, Bianco wrote. At that time, hedge funds and long-only funds were net sellers.

Health-care, consumer and industrial companies were the biggest recipients of inflows from hedge funds, which were net sellers of financial and energy shares. Long-only funds were also net buyers of consumer shares and net sellers of financials. They were net sellers of health-care and industrial stocks, and net buyers of technology companies."

"We are not taking the post down, but this disclaimer stands: viewer beware."

A controversial but revealing post on Alphaville:

"Bank picture du jour( DOESN'T KEDROSKY HAVE THIS PATENTED? ) Posted by Neil Hume on Jan 21 12:36.

A caveat - We have received a slew of complaints in the comments and more than one email about this picture. One reader notes, for instance, that the graphic “just happens to make JPM look like the best bank by far. Represented correctly by area, things are not quite so clear cut between JPM and santander/HSBC.”

Points well taken. We are not taking the post down, but this disclaimer stands: viewer beware.Hat Tip JP Morgan (Click to enlarge).

This entry was posted by Neil Hume on Wednesday, January 21st, 2009 at 12:36 and is filed under Capital markets. Tagged with JP morgan."

Any graph can be misread or misleading.

Below we highlight current credit default swap prices for 24 financial firms across the globe.

From Bespoke:

"Financial Company Default Risk

While default risk has dropped dramatically( GOOD NEWS ) for the financial companies listed below, it's still interesting to see how the firms compare with each other on the CDS front. Below we highlight current credit default swap prices for 24 financial firms across the globe. These prices represent the cost per year to insure $10,000 worth of debt for 5 years. As shown, default risk is the highest for Morgan Stanley, followed by Goldman Sachs, American Express, UBS, and Citigroup. The premium against default for JP Morgan is the lowest among US financial firms, with Wachovia, Wells Fargo, and Bank of America not far behind. BNP Paribas and Credit Agricole have the lowest default risk of the 24 financial firms shown.

"claims would need to reach just over 1 million per week now to be comparable to that level relative to the size of the labor force"

Some possible good news from Across The Curve:

"Initial jobless claims have been hitting multi decade highs as the recession deepens. Economists at UBS make the point that with the expansion in the labor force claims would need to average about one million per week to equate to the weakness evident in the Reagan/Volcker recession of the early 80s. Here is an excerpt from their note:

Jobless claims rose to 586k from 556k; the 4-week average rose to 558k from 544k. The latest reading is the highest since 1982, but the labor force has grown 53% since then. Relative to the size of the labor force, the level of claims is at its highest since 1992. In 1982, new claims reached 695k, with the 4-week average peaking at 674k; claims would need to reach just over 1 million per week now to be comparable to that level relative to the size of the labor force—that is highly unlikely in our view, just as we expect the unemployment rate to peak at a significantly lower level in this cycle than in 1982 (8.3% vs 10.8% in 1982)."

This is good news, although nothing is written. Remember, I believe that many of the layoffs are proactive and not tied to the fundamentals. Therefore, I predict that employment will pick up next year after the Obama Administration is in office and the Fear and Aversion to Risk subsides.

"All were looking for gains this year, and their targets at the start of the year are far above where the S&P 500 is currently trading."

This isn't fair, really, but if you're going to pretend that you can predict the future better than anyone else, it shouldn't be unexpected. I guess when you're wrong, as I told John Gapper, it's better to be gloriously wrong. From Bespoke:

"Bloomberg recently surveyed market strategists for their 2009 S&P 500 price targets, and collectively, they're looking for a gain of 21.8% from the index's current price level. As shown below, UBS is the most bullish of the group with a year-end 2009 price target of 1,300 (a 47.2% gain). UBS was the most bullish last year as well with a 2008 price target of 1,700. Goldman and Strategas are the second most bullish this year with price targets of 1,100. Credit Suisse has a target of 1,050 (for mid-year '09), Citi and HSBC are at 1,000, and Merrill Lynch is at 975. Merrill is the least bullish strategist of those surveyed, but they're still looking for a gain of 10.4% from current levels.

For those looking for direction from these strategists, their 2008 projections should be noted. All were looking for gains this year, and their targets at the start of the year are far above where the S&P 500 is currently trading.

Interested in more in-depth market analysis from Bespoke? Subscribe to Bespoke Premium and start receiving our closely followed reports today.

"Auction rate securities investors at Citi and UBS will be made whole under today’s settlement with the SEC…

Cate posts on Shopyield about Citi and UBS being made whole:

"Made whole…

Thursday, December 11, 2008

Auction rate securities investors at Citi and UBS will be made whole under today’s settlement with the SEC…

$ 30 billion of making whole… that’s lots of wholeness…

These ARS settlements represent the first time that the major dealers have had to pay an onerous penalty for shoddy fixed income practices… there have been multi-million dollar fines previously but there were never substantial penalities relative to the fees and spread that the firms were making… this is more than a slap on the wrist… this is incentive to improve and tighten fixed income practices for retail customers… right on!

From CFO.com ~~~~ ” … “Today’s settlements are the largest in SEC history, and represent the largest return of customer money in the agency’s 75 years,” said SEC Chairman Christopher Cox.”

The settlements with Citi and UBS will restore about $7 billion in liquidity to Citi customers who invested in ARS, and $22.7 billion to UBS customers who invested in ARS, according to the SEC. Under the settlement, Citi will offer to purchase ARS at par from individuals, charities, and small businesses that purchased those ARS from Citi, even if those customers moved their accounts. Citi also will “use its best efforts” to provide liquidity solutions for institutional and other customers, including facilitating issuer redemptions, restructurings, “and other reasonable means.”

The bank also will pay eligible customers who sold their ARS below par the difference between par and the sale price of the ARS. In addition, it will reimburse eligible customers for any excess interest costs associated with loans taken out from Citi due to ARS illiquidity.

UBS will offer to purchase at par from all current or former UBS customers who held their ARS at UBS as of Feb. 13, 2008, or purchased their ARS at UBS between Oct. 1, 2007, and Feb. 12, 2008, even if they moved their accounts. It will pay eligible customers who sold their ARS below par the difference between par and the sale price of the ARS. UBS also will reimburse customers for any excess interest costs incurred by using UBS’s ARS loan programs….” ~~~~

This interests me because way back when I predicted on a Henry Blodget post on Clusterstock that foreigners, while they were not guaranteed by the US Government, could certainly benefit from a bailout, which, although I felt that it might be avoidable, was certain to occur for Citi if it had to be saved. I am assuming, unless I find out otherwise, that foreigners are being made whole as well if they hold these investments. This is only important because foreigners can certainly profit from and bet on and even influence US Government bailouts, in my opinion. They are part of the equation, even if not falling under explicit government guarantees.

" Investors are going to need to adjust their expectations about interest rates accordingly. "

I like this post by Accrued Interest because it's so clear, which I dearly appreciate:

"T-bills at zero? 2-year notes less than 1%? 5-year notes less than 2%? Locking up your money for 30-years at 3.30%?

If these yields make it sound more like you are donating your money to the Treasury rather than lending it to them, you aren't alone. People are going to struggle to buy anything at such low yields."

"But your normal precepts about interest rates are not going to hold in a ultra-low inflation (or possibly deflationary) environment. Be careful reflexively assuming that one should short rates at these levels."

Because short rates mean different things, I believe that he's saying don't bet on interest rates rising.

"Be especially careful taking your bond allocation into cash at this point. Money market rates are much more likely to fall than to rise. Currently fed funds futures predict an 64% chance that the Fed will cut to 0.5% on December 16, and a 36% chance they will cut to 0.25%. Recently, J.P. Morgan joined UBS and others expecting the Fed to cut all the way to zero eventually. At that point, 2% on 5-year notes won't seem so ridiculous. And the odds are good that short-term rates will stay low for a long time. So holding cash waiting for better yield opportunities isn't likely to be a winning strategy."

He's saying rates at these levels might be wise based on interest rates going lower in the near future. Just go out a little longer, by buying longer term bonds.

"In addition, consider the diversification effect. For most investors, bonds are meant to be an offset to riskier allocations. When stock prices fall, Treasury prices tend to rise, helping to at least stabilize one's portfolio to some degree. If stocks continue to fall, cash rates are all the more likely to got to zero. If stocks rise, you won't be complaining about money lost on intermediate bonds!"

I'm a big fan of diversification, but I'm not an investor or offering investing advice. I'm more interested in where the economy is going.

"Of course, ultra low rates hurt income oriented investors the most, such as someone already retired. Those investors really should be looking away from Treasury bonds at this point anyway. 5-year Treasury rates might only be 2% but five-year non-call Agency bonds are still north of 2.75%. For that matter, 5-year municipal bonds are still available at 3% tax free. Agency-backed mortgage bonds carry yields over 5%. These are all sectors where buy-and-hold investors should be able to find bonds with minimal credit risk, and can therefore ignore periodic marks and just collect the income."

Look at other bonds which have higher risk, but not substantially so. Also, check the guarantees and insurance on what you buy.

"So when you see interest rates hitting all-time lows, remember that the U.S. hasn't faced this confluence of deflationary forces since the Depression. Investors are going to need to adjust their expectations about interest rates accordingly."

I'm an inflation man, but this could well be correct. He surely knows a lot more than I do, so I'm listening. Plus, he does manage to make counterintuitive concepts for me clearer, which, again, I really appreciate.

"I've written myself into a corner, now, and can't think of any way to get out of writing the promised blog entry on super-senior tranches"

Felix Salmon considers Super-Senior Tranches:

"I've written myself into a corner, now, and can't think of any way to get out of writing the promised blog entry on super-senior tranches. Especially when Kevin Drum asks so nicely. So here it is. Deep breath..."

Steady on, old boy. Try explaining Godel's Proof.

"By now, you understand how a synthetic bond can behave very much like a real bond."

Let's just say it's exactly like a real bond, so we don't have to mess around with qualifiers.

"So consider the situation of a bank, which has made a bunch of loans, to 100 different companies. The companies all value their relationship with the bank, and the bank values its relationship with the companies. At the same time, however, the bank would like to free up some capital. It doesn't want to sell the loans outright -- so instead it creates a synthetic bond referencing those 100 credits, and sells that."

Free up some capital. More like avoid capital requirements or invest in things they're not supposed to, but let's humor them. They don't want to scare their customers into believing that they'll be engaging in dicey investments.

"Essentially what the bank is doing is taking the interest payments from the companies it's lent money to, and using them to make insurance payments against those companies defaulting. If the companies default, the buyers of the synthetic bond end up sending money to the bank, which will offset its loan losses. The bank has brought down its credit exposure to those companies even though it hasn't sold the actual loans. And because its credit risk has come down, its capital requirements have come down too, and the bank has more free capital to use elsewhere."

Sure, tell your customers that you've bought insurance in case they default. Okay. In this example, if I understand it, the bank created the CDSs ( Insurance against defaults ), and then sold them to some investors who are betting the CDSs don't explode. In other words, the investors are supplying insurance to the bank. So the investors must be getting a premium payment from the banks. Presumably the credit risk of the bank determines its capital requirements, which are significantly less now that they have the insurance provided by the CDSs, thereby giving them the difference between the new and old capital requirements to invest, less the premiums and cost involved in creating the CDSs. Fine. Even if this isn't Felix's example, it's why I believe that they did this.

Bank: Capital Requirement Before CDSs= $100,000
Capital Requirement After CDSs= $50,000
The bank now has $ 50,000 ( Less what I just said ) to lend out and make more revenue

"Because the loans are still on the bank's books, it needs to take mark-to-market write-downs on those loans if they fall in value but don't default. On the other hand, when that happens the value of the bank's default insurance is almost certain to rise by a very similar amount. So the bank really has managed to construct a pretty good hedge here. Not perfect: no hedge is perfect. But pretty good."

The loans are worth less, but the CDSs are worth more. A balancing or cancelling out effect, in essence. A hedge.

"So far so boring. But of course banks are never happy with simple hedges: they want to make money from all this financial high technology. (Incidentally, it's not clear that they won't: Alan Kohler had a thought-provoking column a couple of weeks ago saying that once a few more big defaults happen, "a mass transfer of money will take place from unsuspecting investors around the world into the banking system. How much? Nobody knows, but it's many trillions.")"

Come on. So I've got to read this Kohler post as well?

Let's see: A transfer from unsuspecting investors to banks. Isn't that our system?

"In any event, let's go back to the synthetic bond that the bank issued. Let's say it's structured so that each of the companies is paying an identical amount in interest every year: call it $1 million each. If the bank bundled up all those loans into a collateralized loan obligation, or CLO, then the CLO would be paying out $100 million a year, unless or until one of the companies defaulted."

The insurance equals the interest paid. That's not a great deal for the bank, is it?

Hold on. Who owns the CLO? The bank, right. But I thought that they were the ones buying insurance. So the CLO is paying out premiums for the insurance? Right?

"But rather than just sell the CLO outright, the bank would most likely split it up into tranches. Companies default, but they don't all default at once."

This is why tranches or slices work. You can use the uneven rate of defaults to organize the defaults as they occur into groups or slices of default. It's not an even rate, so you can map out the bumps, if you will, into slices.

"If the companies in question were all investment grade, you could be sure that at least 80 of them would still be making interest payments at any one time. So if you sell off the right to the first $80 million of interest payments, the ratings agencies will slap a triple-A rating on that income stream, and it can be sold at a tight spread and a pretty high price."

You're taking the least risky payers and matching them up with the least likely defaults. Well, that makes sense, since they're the same.

"Then the next $5 million might have a double-A rating, and the next $5 million a single-A rating, and the next $5 million a triple-B rating, and the last $5 million will either have a junk rating or else just be considered "equity"."

Same deal, going from least risky,to middling risky, to very risky, to hold onto your hats risky.

"Now it's possible that the bank will contrive to make a small profit here, if the sum of the value of all the tranches is greater than the amount of money that the bank lent out in the first place. But the operative word is small. "

Of course it's small. They're taking the payments and buying insurance with them. It's a miracle that they don't lose money.

"How do things change if the bank issues a synthetic bond rather than a cash CLO? Well, it can sell off the equity and the junk and the single-A and the double-A tranche, thereby protecting itself if interest payments fall by $20 million. It can then sell off a bit of the triple-A tranche, protecting itself if payments fall by $25 million. Now remember that the first $80 million of payments are rock-solid, risk-free: that's why they carry triple-A ratings. So the bank's remaining risk, after selling off that triple-A-rated synthetic tranche, has been brought down to safer-than-triple-A levels. Some of the banks referred to it as a "quadruple-A" risk, although that's not a real-world rating. But the banks were so comfortable that defaults at that level could never happen that they didn't feel any need to hedge themselves against it happening."

The banks sell the least risky stuff, figuring that they're safe, and so make some money from them.

"Janet Tavakoli, back in 2003, published a nice little table of the difference between a cash CDO and a synthetic one:

	Cash CDO*
	Tranche Size	% of Portfolio
Super Senior	N/A
Aaa	439,500,000	87.9%
Aa2	11,500,000	2.3%
Baa2	14,000,000	2.8%
Equity	35,000,000	7.0%
Total	500,000,000	100.0%
	Synthetic CDO**
	Tranche Size	% of Portfolio
Super Senior	432,500,000	86.5%
Aaa	20,000,000	4.0%
Aa2	12,500,000	2.5%
Baa2	15,000,000	3.0%
Equity	20,000,000	4.0%
Total	500,000,000	100.0%
*Baa2 average portfolio rating. Up to 15% high yield and 10% asset backed. **Baa2 average portfolio rating. Exclusively investment-grade portfolio. ©Collateralized Debt Obligations and Structured Finance, John Wiley & Sons, 2003 by Janet Tavakoli

There are nuances and differences here that we don't need to worry about too much. But the main thing to notice, in this example, is that a bank could protect itself against the first 13.5% of a group of bonds defaulting, and then declare that it was fully hedged: even the triple-A tranche had been sold off, and all that remained was a risk-free super-senior tranche.

Clearly, the cost of protecting yourself against 13.5% of a group of bonds defaulting is lower than the cost of protecting yourself against 100% of that group of bonds defaulting. Not a lot lower, since no one really imagined that more than 13.5% of the bonds could ever default. But enough lower that the bank could end up making a nice profit by selling off the credit risk associated with the bonds, and holding on to the excess income."

It looks like 1.2 %. This example is kind of funny, but let's go on. I mean, one of the benefits are the fees that get charged when you sell them, but I've dealt with that in other posts.

"Of course, the bank's loan position is not actually fully hedged. But so long as more than 86.5% of the interest payments get paid, the bank is fine. And the advantage of leaving the rest of the loan portfolio unhedged is that you don't need to use all the income from the loans to buy protection on them. There's money left over -- which can be considered interest on the quadruple-A, or super-senior, tranche that the bank retains."

So you fudge on the premiums.

"The invention of the super-senior tranche, then, was a way of letting banks have their cake and eat it too. They could take a bunch of debt onto their balance sheets, "fully" hedge it (with only that it-could-never-default tranche left over) and book all the remaining cashflow as pure profit with no credit risk."

Looks good on paper, does it? Remember, they've fudged on their insurance. There's a gap in their coverage now. Understand that.

"Now so long as you're dealing with a hundred different investment-grade corporate loans, this actually works: such things really don't all default at the same time. Banks even found a (limited) market for these super-senior tranches, by allowing their hedge-fund clients to take very leveraged bets on them -- they felt that the leverage was safe, since there was no default risk. But a huge proportion of the super-senior tranches was never sold off to hedge funds, and instead remained on the banks' balance sheets."

There's a good reason for that having to do with capital requirements, but I can't quite fit it into this example.

"And of course it wasn't long until the banks started doing the same thing with mortgage bonds. They would take a bunch of subprime-backed CDOs, and treat the interest payments from the CDOs much as they treated the interest payments from corporations."

It took a coffee break before they were ready to expand the plan to mortgages. Mortgages need that extra little jolt of energy from the caffeine.

"Oops.

In the case of CDOs, as we've all seen, the models said that there was geographical diversification in the housing market; they said that national housing prices, in aggregate, never went down. (Which was true, until it wasn't.)"

I like to think of it like insurance on your house. If a disaster occurs, fire or hurricane say, it usually occurs in one area, even if a large area, of the country, at one time. It's a contained insurance claim. Now, imagine using that model for houses. If housing prices fall, they do so in contained areas like fires and floods. That's the model.

"And somehow they said that thanks to the magic of securitization and overcollateralization, you could create not only triple-A securities from triple-B-rated subprime assets, but even quadruple-A super-senior tranches, too.

And so the banks took billions of dollars of subprime-backed mortgage securities onto their books, and "fully" hedged them while not really hedging most of them at all. When the income from those CDOs went (or was expected to go) towards zero, the banks had to write off assets which they never really considered risk assets at all. The banks thought that they had hedged all the credit risk associated with the bonds, and were left with a modest and super-safe income stream. Instead, they were left with a time bomb."

The whole point, in fact, was to lower capital requirements for lending. Let's not get fancy.

"It's worth noting here that although the bank used CDS technology in the process which ended up with these super-senior tranches, it's not the credit default swaps themselves which blew up. Remember that the bank had a lot of CDOs on its books, and the credit default swaps helped protect the bank from a lot of the losses associated with those CDOs. Just not all of them. And if you underwrite hundreds of billions of dollars' worth of CDOs, the "unfunded" portion of those CDOs can become enormous on an absolute level -- and if it gets wiped out, you can get wiped out."

That's a fair point. Some of the CDSs the banks would have would pay them for the defaults. It's terribly complicated for banks to unwind these deals and see what's what. From my perspective, that's a very good reason not to do them, but I'm not a fan of complexity.

"As ever, credit default swaps, like any derivative, were and are a zero-sum game: they don't cause big losses themselves. The super-senior losses, ultimately, come from the subprime mortgage market, not from the CDS market. But without the technology of credit default swaps, banks would never have been able to retain those exposures while thinking that they had divested themselves of all the associated risk."

Now, subprime mortgages were inexcusable. Human Error. And if they wouldn't have used these investment vehicles, they would have found something else. The main objective was decreasing capital requirements for lending. However, it is possible that these vehicles were seriously more destructive than other alternatives, but we'll never know that for sure.

"Still, no amount of regulation of the CDS market would have solved the underlying problem, which really had nothing to do with the credit default swaps themselves, and everything to do with the banks' risk models. Those models said that if you take on this risk and sell that risk, you're fully hedged. They were wrong. The CDS, so far, have worked. The investors who bought the higher-risk tranches of the synthetic CDOs have been wiped out -- the banks, essentially, have taken nearly all their money. If the CDS contracts hadn't worked (if, for example, the government decided "to simply annul the credit default swaps as void", as Ben Stein has proposed), then the banks would have lost even more. "

The models were wrong, but people were conditioned to believe them by their interests and needs. Every model needs a human being to interpret it. Period. Don't blame the models. Blame the human predisposition to put faith in risky models. Please. And don't blame the investments, as they were simply filling a need. The Stein proposal made no sense, as I said on Felix's blog. Getting something is generally considered better than getting nothing.

"I'm not saying that the CDS market protected the banks from losses: without it, the banks would never have taken all those mortgage-backed CDOs onto their books in the first place. They never thought of themselves as being in the storage business; they thought they were in the moving business. But without senior management ever really realizing it, banks like Citi ended up storing hundreds of billions of dollars' worth of subprime bonds on their balance sheet, and failed to properly account for them because they erroneously thought those bonds were risk-free."

I don't believe it for a second. On this blog, there's a post, where I spent time searching the web and constructing a profile of these investment in less than two hours, as if I were in 2005. In other words, I confined my sources to 2005 and earlier. That prospectus clearly showed that these investments were very risky, even taking in to account what the creators of the models said about them. I'm not saying it predicted what happened, but nobody, nobody, can honestly say that these investment vehicles were not risky. And that's why Bob Rubin's quote in the NY Times admitting this is so important.

"Ultimately, then, the error was one of management, not of financial technology. The banks' balance sheets -- and those of their off-balance-sheet vehicles -- were expanding faster than the banks' executives and risk managers could really keep a handle on. And rather than call a halt to that which they didn't fully understand, they handed down edicts instructing the CDO desks to keep on dancing for as long as the music was playing. Most of the executives probably never even heard the term "super-senior" until those tranches started getting written down. It was their own incuriousness, rather than any CDS technology, which was really their undoing."

Then that's, at the very least, negligence. You're responsible for people's money, for God's sake. This behavior amounts to fraud or negligence or fiduciary mismanagement, and, if not criminal, there should be some way for investors to be compensated by these people for their disatrous handling of other people's money.

One thing that this blog will show, these products are not incomprehensible or unexplainable, at least as to their risk.

By the way, you should read the questions that people asked on Felix's blog. It's his model, so he should be able to answer them.

Well, he answered them.

"Super-seniors are not easy things to understand, as you'll know if you managed to trudge through my attempted explanation. I got some good questions in the comments, here's my attempt at the answers.

Eli and fresnodan both bring up the issue of counterparty risk: after the bank has bought insurance on its CDOs, how does it know that its counterparty will have the money to pay up if and when there is an event of default?

It doesn't always know for sure. But remember that synthetic bonds are structured so that the collateral payment gets invested up-front, so if the bank hedged its exposure by issuing synthetics, it's probably fine."

Truthfully, this investigation is like investigating any counterparty.

"On the other hand, as Noel notes, some banks ended up buying cheap protection on their super-senior tranches from AIG Financial Products. Which, as we've seen, was a very good deal for the banks, and a very bad idea for AIG. And, thanks to Uncle Sam, AIG is still around to pay out on those contracts."

AIG's whole reason on doing their tranches was avoiding capital requirements. All of their problems, as far as I can tell, from these types of investments come from their very reason for getting into them. On the other hand, it's a good question if investors believed that these investments were collateralized like AIG's insurance. I've no idea, but not to explain the difference to investors is, at least , negilgence.

"Matthew asks a couple of questions. Firstly:

What's the difference between this scenario than the bank just lending money to the top 86.6% of companies by creditworthiness and letting other lenders - perhaps specialists - lend to the other 13.4%? And aren't the profits the same for the bank in both cases?

The answer is that it's not the bottom 13.4% of companies by creditworthiness which always default. You don't know which companies are going to default: you just know that some but not all companies are likely to. So you lend to them all and then protect yourself against the first 13.4% of losses. It's a bit like saying "whoever the losers are, those companies, in hindsight, we'll choose not to lend to"."

Actually, I think this is better understood using other examples. He's right, but it's not obvious.

"His second question is this:

Why would the income from the CDOs go 'to zero'? This would mean all 100% of mortgage payers (in this example) default. If this is the case then the problem is massive failure to understand the riskiness of an asset- but it would have to be absolutely massive to get it 100% wrong? In fact so massive, fraudulent, instead?

I tried to explain this here, in words, and here, in pictures. But in a nutshell, these CDO weren't simple pools of mortgages. Instead, they were pools of junior tranches of mortgage-backed securities. And the junior tranche can go to zero even if quite a lot of homeowners continue to pay their mortgages in full and on time."

The lesser grades blow up first. That's the point of differing tranches and risks.

"Anon asks whether "at least one factor in the ongoing 'success' of these instruments was based on expectations of a declining USD" -- no. But he or she is quite right that the bankers

remained focused on short term profit pressures in the absence of 'new' ideas, confident both in apparent limits to their own personal liability and understanding that their firms would be too big to fail when the music stopped - and protected by bonuses and severance packages which would see them into very comfortable retirements IF proprietary knowledge of their firms did not keep them in demand for the rest of their careers."

Actually, the second part is spot on.

"And finally Kevin Drum reads me as saying that the banks were "creating a synthetic version of the subprime market that was even bigger than the original". This isn't really true: they created a synthetic version of the subprime market that was actually smaller than the original -- that was the problem, that it didn't fully hedge the subprime assets they held on their books."

That was the problem, that they didn't have enough capital. But, theoretically, at least, you could have had a larger market. But you do need to find buyers and sellers, and so there is a natural limit to this crap.

"Kevin also says that the banks kept synthetic subprime CDOs on their own books -- which happened in a few cases, notably at UBS, but was actually pretty rare. Normally they kept the real CDOs on their own books, and hedged by creating and selling the synthetics."

The CDOs allowed them to create investments of higher risk as if based on lower risk if the banks kept the CDOs on their own books.

I can't believe that I have to do more posting on this stuff today, if I can finally get around to it.