There is (I think and hope) a growing number of us in the markets now that wonders what madness has gripped Stock Indices again, even as we watch the major markets merrily march towards money mayhem and, I believe, an inevitable sorry end to this buying frenzy. Firstly, the idea that everything is dandy, and we are inevitably into a sustainable economic recovery is laughable…as is its foundation in the Ben Bernanke belief (100% conviction, he proclaims!) that any inflationary consequences from the Quantitative Easing festival can be quickly nailed in the bud …..the Fed’s newfound zest for higher inflation and employment to the detriment of its monetary perspective is bemusing at best. There is stark reminder in markets of the now-infamous statement of a major CEO that while the music is still playing, the dance is on.
The resultant hangover is potentially going to be huge. And there is little point claiming it was all so unexpected
And rates meanwhile keep climbing, with Treasuries hurdling 3.5% so far from 2.5% just a few weeks ago..
I fear an almighty crash, with the Eurozone crisis perhaps offering the tipping point.
Don’t BLINK !
Thursday, December 16, 2010
Monday, December 6, 2010
Some Principles of Investing, and of Risk Management
Aditya Rana’s timeless gems on the principles of Investing could well be read as the Principles of Risk Management for these times; some of them are:
- Start saving early and regularly - but it is never too late to start.
- The simple strategy of indexing has outperformed the vast majority of equity and bond funds
- Diversify - across securities, asset classes, markets and time, and across time
- Rebalance your portfolio periodically and in a disciplined manner
- Avoid major mistakes
- Avoid following the herd and getting caught up in periodic moods of overconfidence or discouragement
- Minimize your investment costs
- Avoid “exotics” like venture capital, private equity and hedge funds as only the best performers in each category achieve great results and are closed to most individual investors.
- Make your asset allocation decisions, based on your particular financial situation (in terms of assets, income and savings), your age, your emotional strengths (to withstand market volatility) and your knowledge of and interest in investing.
- “Everything should be made as simple as possible-but no simpler” in the words of Albert Einstein and this maxim applies to the investment world as well.
Read more in his blog update.....http://j-risknotes.blogspot.com/p/adityas-blog.html
- Start saving early and regularly - but it is never too late to start.
- The simple strategy of indexing has outperformed the vast majority of equity and bond funds
- Diversify - across securities, asset classes, markets and time, and across time
- Rebalance your portfolio periodically and in a disciplined manner
- Avoid major mistakes
- Avoid following the herd and getting caught up in periodic moods of overconfidence or discouragement
- Minimize your investment costs
- Avoid “exotics” like venture capital, private equity and hedge funds as only the best performers in each category achieve great results and are closed to most individual investors.
- Make your asset allocation decisions, based on your particular financial situation (in terms of assets, income and savings), your age, your emotional strengths (to withstand market volatility) and your knowledge of and interest in investing.
- “Everything should be made as simple as possible-but no simpler” in the words of Albert Einstein and this maxim applies to the investment world as well.
Read more in his blog update.....http://j-risknotes.blogspot.com/p/adityas-blog.html
Monday, November 29, 2010
The State of the (European) Union...and Deleveraging in focus
The state of the (European) Union is quite terrible.
Europe, and the Euro, continues to unravel. Ireland did its thing on an Eu/IMF rescue package and the market gave it about a 15-minute welcome before hammering it, taking Potugal, Spain, Italy alongside. Many major commentators continue to spew venom at the ongoing tale of privatizing leverage and profits, while socializing losses and risk. Banks are not the most beloved institutions anywhere in the world, and the idea that banks and bondholders are being kept as pain-free as possible in this hastily-cobbled deal does have no chance of any popular support: there is no certainty at all that the Irish Budget will pass on Dec 7 or that the government will remain anything but lame duck. That has left Euro leaders notably Ms Merkel of Germany and Mr. Sarkozy of France scrambling to defend the currency union.
Aditya Rana quotes from Gary Shilling’s The Age of Deleveraging: Investment Strategies for a decade of slow growth and deflation and calls it a must read for serious students of markets and investing, starting off with saying that after four decades of leveraging up by the financial and household sectors, deleveraging is underway which is likely to take a decade or more. He says further crises lie ahead: another sovereign debt crisis in Europe with Ireland being the focus, a further 20% drop in US house prices due to the excess inventories and foreclosure delays which could push the number of underwater homeowners from 23% to 40% of mortgagors causing a sharp fall in consumer spending , a crisis in US commercial real estate which could exceed the housing crisis, a hard landing in China and a slow-motion train in Japan due to lower demand for its exports and an ageing population.
In terms of the current market, I continue to believe that long-dated US Treasuries offer exceptional value from a 6-month horizon with current yields at 4.30% - the ETF ZROZ, which invests in long-dated zeros, is currently trading at 73 (after having gone down to 69 last week) and has the potential to move towards 100 over the course of 2011. The US$ has, as expected, commenced its appreciation versus the Euro and is likely to continue to do so into the early part of 2011. Expectations of further QE programs are likely to cause sharp reversals in the US$, followed by periods of steady appreciation. Select EM equity markets are likely to be the main beneficiaries of QE programs, while grappling with high domestic inflation and real (and some nominal) currency appreciation.
Europe, and the Euro, continues to unravel. Ireland did its thing on an Eu/IMF rescue package and the market gave it about a 15-minute welcome before hammering it, taking Potugal, Spain, Italy alongside. Many major commentators continue to spew venom at the ongoing tale of privatizing leverage and profits, while socializing losses and risk. Banks are not the most beloved institutions anywhere in the world, and the idea that banks and bondholders are being kept as pain-free as possible in this hastily-cobbled deal does have no chance of any popular support: there is no certainty at all that the Irish Budget will pass on Dec 7 or that the government will remain anything but lame duck. That has left Euro leaders notably Ms Merkel of Germany and Mr. Sarkozy of France scrambling to defend the currency union.
Aditya Rana quotes from Gary Shilling’s The Age of Deleveraging: Investment Strategies for a decade of slow growth and deflation and calls it a must read for serious students of markets and investing, starting off with saying that after four decades of leveraging up by the financial and household sectors, deleveraging is underway which is likely to take a decade or more. He says further crises lie ahead: another sovereign debt crisis in Europe with Ireland being the focus, a further 20% drop in US house prices due to the excess inventories and foreclosure delays which could push the number of underwater homeowners from 23% to 40% of mortgagors causing a sharp fall in consumer spending , a crisis in US commercial real estate which could exceed the housing crisis, a hard landing in China and a slow-motion train in Japan due to lower demand for its exports and an ageing population.
In terms of the current market, I continue to believe that long-dated US Treasuries offer exceptional value from a 6-month horizon with current yields at 4.30% - the ETF ZROZ, which invests in long-dated zeros, is currently trading at 73 (after having gone down to 69 last week) and has the potential to move towards 100 over the course of 2011. The US$ has, as expected, commenced its appreciation versus the Euro and is likely to continue to do so into the early part of 2011. Expectations of further QE programs are likely to cause sharp reversals in the US$, followed by periods of steady appreciation. Select EM equity markets are likely to be the main beneficiaries of QE programs, while grappling with high domestic inflation and real (and some nominal) currency appreciation.
Tuesday, November 23, 2010
Contagious Times
"Contagion" is the new key word in markets. And risk aversion is a natural consequence. Hence the flight to the US Dollar, and Gold
The Europeans are struggling to keep their act (and their currency) together, even as Ireland stutters through the economics and politics of trying to get a basic bank rescue fund in place, and the IMF (as well as the rating agencies) even marginally satisfied. Irish, Portugese, Spanish, and Greek bonds are trading at life-time high yields. Markets are quick to focus on Spain (and the other peripheral European dalliance partners) even if they scent an Ireland rescue coming together (if the Irish Government that negotiated this rescue even lasts to be able to see it through!). Meanwhile, in a finalist slot for understatement of the year, the Irish central bank governor Honohan says that “confidence in the banks and government is well below what is justified”.
Germany’s Merkel says the Euro is in an "exceptionally serious situation, there is no alternative to German budget austerity"; she sees at best 'decent' German GDP growth soon. Merkelisms otherwise focus on the post-2013 Euro rescue system (while markets worry about how we will even get there in one piece) as she pontificates that it “must involve investors but politicians need 'primacy' over markets”. German Finance Minister Schaeuble weighs in with “Germany is not swimming in money but drowning in debt; the future of the joint currency is at stake”. Even as I write this, that currency (the Euro) is as close to bid-less today as it can possibly get.
Otherwise, things are okay. To paraphrase various literary pieces today "The Koreans are back in ‘explosive mode” throwing loud things around, the FBI is serving hot warrants around the Street, and everywhere you look you see a sea of joblessness, a housing market that remains very soft, absolute records in deficits, two open-ended wars that have got off the front pages for a bit, an im/exploding mortgage-backed securitization problem of gargantuan intensity, the Federal Reserve continuing to print money as its predominant tool of considered monetary policy, many US States and municipalities in doomsday-level financial peril...."
Not much fun out there folks, even as we head to a Thanksgiving break. If anything the Thanks may just be due for the break !
Jaidev
The Europeans are struggling to keep their act (and their currency) together, even as Ireland stutters through the economics and politics of trying to get a basic bank rescue fund in place, and the IMF (as well as the rating agencies) even marginally satisfied. Irish, Portugese, Spanish, and Greek bonds are trading at life-time high yields. Markets are quick to focus on Spain (and the other peripheral European dalliance partners) even if they scent an Ireland rescue coming together (if the Irish Government that negotiated this rescue even lasts to be able to see it through!). Meanwhile, in a finalist slot for understatement of the year, the Irish central bank governor Honohan says that “confidence in the banks and government is well below what is justified”.
Germany’s Merkel says the Euro is in an "exceptionally serious situation, there is no alternative to German budget austerity"; she sees at best 'decent' German GDP growth soon. Merkelisms otherwise focus on the post-2013 Euro rescue system (while markets worry about how we will even get there in one piece) as she pontificates that it “must involve investors but politicians need 'primacy' over markets”. German Finance Minister Schaeuble weighs in with “Germany is not swimming in money but drowning in debt; the future of the joint currency is at stake”. Even as I write this, that currency (the Euro) is as close to bid-less today as it can possibly get.
Otherwise, things are okay. To paraphrase various literary pieces today "The Koreans are back in ‘explosive mode” throwing loud things around, the FBI is serving hot warrants around the Street, and everywhere you look you see a sea of joblessness, a housing market that remains very soft, absolute records in deficits, two open-ended wars that have got off the front pages for a bit, an im/exploding mortgage-backed securitization problem of gargantuan intensity, the Federal Reserve continuing to print money as its predominant tool of considered monetary policy, many US States and municipalities in doomsday-level financial peril...."
Not much fun out there folks, even as we head to a Thanksgiving break. If anything the Thanks may just be due for the break !
Jaidev
Saturday, November 20, 2010
QEII
Aditya Rana writes....
Criticisms of QE2 have centered around its inability to increase growth and reduce unemployment while stoking inflationary pressures in the economy through an increase in money supply. As pointed out in last week’s newsletter, the impact of quantitative easing on the economy is likely to be muted while its impact on increasing asset prices can be significant. However, it is unlikely to have any impact on inflation in the developed world due to prevailing excess capacity and lack of credit growth. But, most importantly, it does have a significant impact on increasing asset prices and inflation in emerging markets as argued by two star managers at the well known hedge GLG in the FT last week.
Read more on the Aditya Rana page in this Blog Post......
Jaidev
Criticisms of QE2 have centered around its inability to increase growth and reduce unemployment while stoking inflationary pressures in the economy through an increase in money supply. As pointed out in last week’s newsletter, the impact of quantitative easing on the economy is likely to be muted while its impact on increasing asset prices can be significant. However, it is unlikely to have any impact on inflation in the developed world due to prevailing excess capacity and lack of credit growth. But, most importantly, it does have a significant impact on increasing asset prices and inflation in emerging markets as argued by two star managers at the well known hedge GLG in the FT last week.
Read more on the Aditya Rana page in this Blog Post......
Jaidev
Monday, November 15, 2010
Risk Appetite ....is back, at least in the soul-search!
There is new market-wide focus on the creation, adoption and implementation of appropriate Risk Appetite statements for financial firms. The key challenges in this include but are not restricted to: How to define it (top-down, generically and at level of portfolio/marginal risk), How to dimension and communicate it, How to monitor it (reporting issues, common metrics, creation and artistry of a “risk dashboard”), How to test it (potential loss and limits architecture and monitoring, scenario analysis including non-quantitative “what-if” tests), How to reconcile business strategy with it (including acquisitions and divestitures) and not least How to align incentives with it (compensation issues).
Many companies are currently working on detailed statements of Risk Appetite. Boards have begun to insist that they see one and actively discuss the same with the CEO, CFO and CRO. The process includes Dimensioning Risk Appetite, formulating a Statement/s of Risk Appetite, Communicating this all the way along and down the organization.
Risk Appetite dimensions of a firm typically should include a Quantitative and a Qualitative component/s. Quantitative Risk Appetite is articulated at the level of the firm overall, and usually also at one or more subsidiary levels such as key businesses, regions, products, and risk-types as well. Dimensions include
- Economic and Regulatory Risk Capital
- Value-at-Risk, Earnings at Risk, and the requirement that these be related to both the Risk Appetite overall and to the subsidiary structure of product and risk level Limits
- Scenario Analysis & Stress-Testing Results at portfolio and transactional levels.
Some leading banks have operational-ized the Risk Appetite statement - at a portfolio/transaction level, risk-takers and risk-managers must justify, approve, monitor, and report on Stress Returns, and Returns on Capital i.e. RAROC, RORAC, RORC, NIACC etc..
Qualitative Risk Appetite includes some range of acceptable risks and boundaries across
- Businesses that the firm will do and How
- Unusual, Unintended, and Unacceptable risks
- Approach to Legal and Regulatory grey areas
- Ethics and Conflict of Interest Policies/statements
- Loud clarity on unacceptable behavior (articulating policies on, say, sexual harassment and discrimination are relatively easy as they belong in the zero-tolerance zone. Firms seem to find things so-very-difficult once you go beyond these simple examples)
Will be back with more on this as also on Risk Principles, Policies, processes....
Jaidev
Many companies are currently working on detailed statements of Risk Appetite. Boards have begun to insist that they see one and actively discuss the same with the CEO, CFO and CRO. The process includes Dimensioning Risk Appetite, formulating a Statement/s of Risk Appetite, Communicating this all the way along and down the organization.
Risk Appetite dimensions of a firm typically should include a Quantitative and a Qualitative component/s. Quantitative Risk Appetite is articulated at the level of the firm overall, and usually also at one or more subsidiary levels such as key businesses, regions, products, and risk-types as well. Dimensions include
- Economic and Regulatory Risk Capital
- Value-at-Risk, Earnings at Risk, and the requirement that these be related to both the Risk Appetite overall and to the subsidiary structure of product and risk level Limits
- Scenario Analysis & Stress-Testing Results at portfolio and transactional levels.
Some leading banks have operational-ized the Risk Appetite statement - at a portfolio/transaction level, risk-takers and risk-managers must justify, approve, monitor, and report on Stress Returns, and Returns on Capital i.e. RAROC, RORAC, RORC, NIACC etc..
Qualitative Risk Appetite includes some range of acceptable risks and boundaries across
- Businesses that the firm will do and How
- Unusual, Unintended, and Unacceptable risks
- Approach to Legal and Regulatory grey areas
- Ethics and Conflict of Interest Policies/statements
- Loud clarity on unacceptable behavior (articulating policies on, say, sexual harassment and discrimination are relatively easy as they belong in the zero-tolerance zone. Firms seem to find things so-very-difficult once you go beyond these simple examples)
Will be back with more on this as also on Risk Principles, Policies, processes....
Jaidev
Wednesday, October 27, 2010
Run Turkey Run...Gross !
Whether you have or have not read or heard Bill Gross before, here is a great one ... I offer this humbly, and as a great admirer of Gross, but of course not to endorse the explicit PIMCO ad here....!
http://www.pimco.com/Pages/RunTurkeyRun.aspx
http://www.pimco.com/Pages/RunTurkeyRun.aspx
Tuesday, October 5, 2010
Risk Conferences flourish, and a rogue trader does not
Back after a week in San Francisco, and two excellent conferences ….. Moody’s Risk Practitioners Conference, and CFA Institute’s GIPS Conference
I am impressed and delighted by the extent of participation in each of these conferences – would have definitely called the size of the turnout ‘surprising’ given suggestions that companies and people have become very leery and tight-fisted about the money and the time spent out at these market conferences. On the other hand, maybe this was not so surprising given the quality of the organizations behind these events, and the outstanding value provided by the content, presenters, et al.
I spoke at both these conferences, as always shaking my finger at the excesses and the indolence that led to the current crisis, and pleading for lessons to be extracted, learnt, and used going forward. Questions that came at me included ones on Stress-Testing, VaR, quantitative focus in Risk, risk training, Basel 4,5 & 6…..
My big agenda is still People Risk – about the fear and greed that drives risk, (notwithstanding as someone said that to blame greed for the market is like blaming gravity for a plane crash), about how especially in a crisis markets are not efficient and players are not rational, and people don’t behave the same way when they are alone versus in a crowd, or when they are making money versus when they are losing much. And if people are really our greatest assets, like every major corporation on earth will eagerly tell you, then are we really treating and safeguarding them like that were so? As I drove out this morning, I heard that a French court has convicted Jerome Kerviel of Societe Generale in what is the most famous recent case of rogue trading (Bernie Madoff apart). This is a story of a small-time-trader on an arbitrage deck breaking over 140 key controls to build up exposures exceeding $ 70 billion, managing finally to lose over $ 7 billion. The sentence includes 3 years in general, and a promise from Jerome to repay all the money – all 7 billion of it! Good luck with that!!
I am impressed and delighted by the extent of participation in each of these conferences – would have definitely called the size of the turnout ‘surprising’ given suggestions that companies and people have become very leery and tight-fisted about the money and the time spent out at these market conferences. On the other hand, maybe this was not so surprising given the quality of the organizations behind these events, and the outstanding value provided by the content, presenters, et al.
I spoke at both these conferences, as always shaking my finger at the excesses and the indolence that led to the current crisis, and pleading for lessons to be extracted, learnt, and used going forward. Questions that came at me included ones on Stress-Testing, VaR, quantitative focus in Risk, risk training, Basel 4,5 & 6…..
My big agenda is still People Risk – about the fear and greed that drives risk, (notwithstanding as someone said that to blame greed for the market is like blaming gravity for a plane crash), about how especially in a crisis markets are not efficient and players are not rational, and people don’t behave the same way when they are alone versus in a crowd, or when they are making money versus when they are losing much. And if people are really our greatest assets, like every major corporation on earth will eagerly tell you, then are we really treating and safeguarding them like that were so? As I drove out this morning, I heard that a French court has convicted Jerome Kerviel of Societe Generale in what is the most famous recent case of rogue trading (Bernie Madoff apart). This is a story of a small-time-trader on an arbitrage deck breaking over 140 key controls to build up exposures exceeding $ 70 billion, managing finally to lose over $ 7 billion. The sentence includes 3 years in general, and a promise from Jerome to repay all the money – all 7 billion of it! Good luck with that!!
Monday, September 13, 2010
Basel III - Capital needed now, but let's take 10 years to get it
In Basel, Switzerland, global regulators agreed on Sunday new rules aimed at strengthening the existing capital requirements for banks.
The minimum common equity requirement will be raised from 2% to 4.5%. Banks will also be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%.
Regulators settled on a long time-line for implementing the new rules, with some of the requirements becoming fully effective only in 2019.
What I find confusing here is the reaction of markets, at least the first time out. There is a big rally in equities around the world. This seems not so much a celebration of new tighter risk rules and requirements, but more a sigh of relief that banks have so long a period of time to comply. Really?! What does that say about our new-found commitment to managing risk. While I can understand shareholders of any individual institution being happy that the firm does not have to run to the markets for fresh capital in a hurry, it seems to me that in the bigger scheme of things such a long period for compliance is a huge market negative. Wouldn’t we rather see our institutions rushing to beef up their capital positions, instead of having the facts tell us they are under-capitalized but can take 8 or 10 years or whatever (regulatory propensity to allow such compliance dates to slide even further is worth another safe bet).
I am not sure this first reaction can, or should, hold. If risk levels require higher capital ratios, let’s go get it now. 10 years is an eternity, and if you are short of capital now, surely you should be extinct by then.
The minimum common equity requirement will be raised from 2% to 4.5%. Banks will also be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%.
Regulators settled on a long time-line for implementing the new rules, with some of the requirements becoming fully effective only in 2019.
What I find confusing here is the reaction of markets, at least the first time out. There is a big rally in equities around the world. This seems not so much a celebration of new tighter risk rules and requirements, but more a sigh of relief that banks have so long a period of time to comply. Really?! What does that say about our new-found commitment to managing risk. While I can understand shareholders of any individual institution being happy that the firm does not have to run to the markets for fresh capital in a hurry, it seems to me that in the bigger scheme of things such a long period for compliance is a huge market negative. Wouldn’t we rather see our institutions rushing to beef up their capital positions, instead of having the facts tell us they are under-capitalized but can take 8 or 10 years or whatever (regulatory propensity to allow such compliance dates to slide even further is worth another safe bet).
I am not sure this first reaction can, or should, hold. If risk levels require higher capital ratios, let’s go get it now. 10 years is an eternity, and if you are short of capital now, surely you should be extinct by then.
Tuesday, September 7, 2010
Back from a break; market risk aversion remains exceptional
Back after a longish break - much has changed, yet in many respects very little has! Risk aversion is at an exceptional high across the board, but the implications of that are still quite unclear in the markets, and there is a huge amount of short-term flows that is contributing volatility and little else. Even as we grasp for any signs of life in the US economy, Europe is back in the spotlight for sovereign woes and banks debt holdings. The spreads between EU sovereigns have moved to levels that are a make-or-break challenge for EU politicians and central banks. Something has to give, probably starting with the currency.
All this in interesting stark contrast to what I saw in India for the past couple of weeks. Booming, construction everywhere, tremendous amount of middle-class consumer activity, and all this despite the horrendous state of domestic politics – very messy and noisy really!
Two big speeches coming up, at Moody’s Risk Practitioners’ Conference September 27 and at the CFA GIPS Conference Sep 29, both in San Francisco, and at venues that are a couple of hundred feet apart! And I am of course still doing my fire-and brimstone-stuff about paying heed to the lessons learned from this crisis, and at least muting the impact of the next one, since surely we will not avoid one altogether.
So, will be back soon, live. Meanwhile, stay at least risk-aware if not risk-averse
All this in interesting stark contrast to what I saw in India for the past couple of weeks. Booming, construction everywhere, tremendous amount of middle-class consumer activity, and all this despite the horrendous state of domestic politics – very messy and noisy really!
Two big speeches coming up, at Moody’s Risk Practitioners’ Conference September 27 and at the CFA GIPS Conference Sep 29, both in San Francisco, and at venues that are a couple of hundred feet apart! And I am of course still doing my fire-and brimstone-stuff about paying heed to the lessons learned from this crisis, and at least muting the impact of the next one, since surely we will not avoid one altogether.
So, will be back soon, live. Meanwhile, stay at least risk-aware if not risk-averse
Monday, July 26, 2010
Not very stressful - that's the bad news
It was “much of a muchness for nothing very much”. Not that that itself is a surprise!
At the end of the day, the results drew attention to the leniency of the Eurozone stress tests and of the politicization of the process, rather than the robustness of the banking system. The feeling is one of let-down – having said that, the amount of this deflated feeling is probably not huge for markets – I would still like to watch for a day or two to be sure of that. I would not be surprised at all if we did see a drag on most markets.
Here is a quick summary of the Tests, parameters, results et al:
1. Coverage: 91 banks from 20 EU states, covering essentially 65% of the EU banking system and at least 50% of the national banking sector in each country. This includes banks that already receive government support.
2. Thresholds & Assumptions
- Capital: required capital ratio of 6% (Tier 1) under the “adverse scenario”.
Problem: this includes not only capital and retained earnings but also several hybrid instruments, part of which represent government assistance.
- Test parameters: based on a ‘double dip’ scenario, with Eurozone growth at -0.2% in 2010 (vs 0.7% in the benchmark case) and –0.6% in 2011 (vs 1.5% in the benchmark case); and various valuation haircuts to holdings of sovereign debt averaging 8.5% for the EU; ranging from 4.7% for Germany to 12.0% for Spain, 14.1% for Portugal and 23.1% for Greece.
Problem: no sovereign default accounted for (wasn’t this the original reason for these stress-tests?!)
Problem: haircuts applied only to trading books. But most sovereign debt is held in the banking books, in Greece’s case some 90% of its exposure. To me, this is a huge issue
- Test results: Given above, only seven out of 91 banks fail the test, five of which are Spanish cajas (plus Germany’s Hypo Real Estate and Greece’s ATE Bank). Many institutions narrowly passed.
Problem (announced as good news?): the total capital shortfall identified is a petty Eur3.5bn. This fits the pattern of denial by European policymakers and suggests the tests were calibrated in order to generate the desired result.
3. Transparency: The full sovereign exposure of each bank was not revealed despite previous announcements to this effect. Even the releases of national regulatory authorities only provide national aggregates. Germany reneged point-blank on its commitment to do so.
4. Credibility: Given the above-cited shortfalls, the tests significantly lack credibility even though they represent some progress over previous attempts to address vulnerabilities in the banking sector.
5. Communication: Lot of last minute confusion over timing, release of partial information throughout the day, release of German results prior to the announcement by CEBS etc suggest that communication could be handled better. Ex post there seems to be publicly aired disagreement on whether German banks were required to disclose their sovereign exposure by BaFin.
6. Next Steps: N/A
The issue of backstop plans has been rendered somewhat irrelevant given the benign outcome of the tests. Spain is one of the few countries that has a capitalization plan in place and on the basis of the results little further action is required elsewhere. This could yet lead to unwelcome surprises should other banks trip up in the future.
To me, regulators and policy-makers (and of course the politicians) have really gone out on a limb on this one. As close to a new definition of moral hazard as I have ever seen!
I am sorry, but The Emperor has no clothes
At the end of the day, the results drew attention to the leniency of the Eurozone stress tests and of the politicization of the process, rather than the robustness of the banking system. The feeling is one of let-down – having said that, the amount of this deflated feeling is probably not huge for markets – I would still like to watch for a day or two to be sure of that. I would not be surprised at all if we did see a drag on most markets.
Here is a quick summary of the Tests, parameters, results et al:
1. Coverage: 91 banks from 20 EU states, covering essentially 65% of the EU banking system and at least 50% of the national banking sector in each country. This includes banks that already receive government support.
2. Thresholds & Assumptions
- Capital: required capital ratio of 6% (Tier 1) under the “adverse scenario”.
Problem: this includes not only capital and retained earnings but also several hybrid instruments, part of which represent government assistance.
- Test parameters: based on a ‘double dip’ scenario, with Eurozone growth at -0.2% in 2010 (vs 0.7% in the benchmark case) and –0.6% in 2011 (vs 1.5% in the benchmark case); and various valuation haircuts to holdings of sovereign debt averaging 8.5% for the EU; ranging from 4.7% for Germany to 12.0% for Spain, 14.1% for Portugal and 23.1% for Greece.
Problem: no sovereign default accounted for (wasn’t this the original reason for these stress-tests?!)
Problem: haircuts applied only to trading books. But most sovereign debt is held in the banking books, in Greece’s case some 90% of its exposure. To me, this is a huge issue
- Test results: Given above, only seven out of 91 banks fail the test, five of which are Spanish cajas (plus Germany’s Hypo Real Estate and Greece’s ATE Bank). Many institutions narrowly passed.
Problem (announced as good news?): the total capital shortfall identified is a petty Eur3.5bn. This fits the pattern of denial by European policymakers and suggests the tests were calibrated in order to generate the desired result.
3. Transparency: The full sovereign exposure of each bank was not revealed despite previous announcements to this effect. Even the releases of national regulatory authorities only provide national aggregates. Germany reneged point-blank on its commitment to do so.
4. Credibility: Given the above-cited shortfalls, the tests significantly lack credibility even though they represent some progress over previous attempts to address vulnerabilities in the banking sector.
5. Communication: Lot of last minute confusion over timing, release of partial information throughout the day, release of German results prior to the announcement by CEBS etc suggest that communication could be handled better. Ex post there seems to be publicly aired disagreement on whether German banks were required to disclose their sovereign exposure by BaFin.
6. Next Steps: N/A
The issue of backstop plans has been rendered somewhat irrelevant given the benign outcome of the tests. Spain is one of the few countries that has a capitalization plan in place and on the basis of the results little further action is required elsewhere. This could yet lead to unwelcome surprises should other banks trip up in the future.
To me, regulators and policy-makers (and of course the politicians) have really gone out on a limb on this one. As close to a new definition of moral hazard as I have ever seen!
I am sorry, but The Emperor has no clothes
Tuesday, July 20, 2010
Invitation to a Party ... bring your Stress along !!!
Everybody is invited again …… to another Stress Test Party!!
So here we go once more, and whichever way you look at it, the Emperor has no clothes! The ones being really stressed in all this are the Regulators, and of course the markets, you, and !
I have an interesting email from Ash Jaidev, Northwestern University, (Class of 2012 Economics and History)
Quote
I was reading some article and thinking about bank stress-testing overall, and had some thoughts.
So Europe is in the process of developing stress tests for its banks, and there's all this talk about whether those tests are going to adequately reflect the nature of these banks… My problem is this. Let's suppose that there are 10 banks being tested, and all 10 banks "pass" the test. Everyone will think that the regulators' test was inadequate and didn't do enough to challenge the banks, and therefore no one will trust the test.
Now let's suppose that the same 10 banks "fail" the test. Can anyone conclude that the banks are actually all terrible, or that the test itself was too challenging and nit-picky?
What if a bank peforms badly on a stress test: market value and confidence in the bank declines, the bank suffers. The failed test caused the bank to decline, but the bank wasn't declining when the test failed it. Isn't that a paradox/endless cycle? What caused what?
Not sure if I'm being clear with all this. Point is, there is too much responsibility on behalf of regulators to create a stress test that adequately challenges banks while also managing expectations of investors and the market. It seems to me that it is impossible to do both!
Unquote
Cheers
So here we go once more, and whichever way you look at it, the Emperor has no clothes! The ones being really stressed in all this are the Regulators, and of course the markets, you, and !
I have an interesting email from Ash Jaidev, Northwestern University, (Class of 2012 Economics and History)
Quote
I was reading some article and thinking about bank stress-testing overall, and had some thoughts.
So Europe is in the process of developing stress tests for its banks, and there's all this talk about whether those tests are going to adequately reflect the nature of these banks… My problem is this. Let's suppose that there are 10 banks being tested, and all 10 banks "pass" the test. Everyone will think that the regulators' test was inadequate and didn't do enough to challenge the banks, and therefore no one will trust the test.
Now let's suppose that the same 10 banks "fail" the test. Can anyone conclude that the banks are actually all terrible, or that the test itself was too challenging and nit-picky?
What if a bank peforms badly on a stress test: market value and confidence in the bank declines, the bank suffers. The failed test caused the bank to decline, but the bank wasn't declining when the test failed it. Isn't that a paradox/endless cycle? What caused what?
Not sure if I'm being clear with all this. Point is, there is too much responsibility on behalf of regulators to create a stress test that adequately challenges banks while also managing expectations of investors and the market. It seems to me that it is impossible to do both!
Unquote
Cheers
Tuesday, July 6, 2010
Financial Reform
Here is a quick bullet-point view on the product of the Washington Sausage Factory….
➢ Oversight
o Financial Services Oversight Council
• Monitors financial markets
• Powers to determine tougher regulations across some institutions
• Power to break up large financial firms if they are deemed to pose a “threat”
➢ Consumer Protection
o Within Federal Reserve
o Power over credit cards, mortgages and loans
• Auto dealers exempt
• Regulators can appeal council by a veto 2/3 vote
• Case by case actions
➢ Federal Reserve
o Retains supervision over bank-holding companies
o Polices large interconnected non-bank institutions based on oversight council determination
o With council approval, power to break up large financial firms
o To be audited by Congress’s investigative arm for emergency lending around 2008 crisis.
• Low cost loans Fed provides to banks, and securities actions will be audited.
➢ Bank Capital Standards
o Higher risk and size based capital standards for Banks with more than $250 bio in assets
o Certain hybrid securities no longer to be considered Tier 1 capital
o Banks < $15 bio retain trust preferred securities, while large banks must phase them out
➢ Derivatives
o Majority to be on a regulated public exchange. Banks must spin off swaps/swap shops?
o Banks can continue to trade derivatives related to interest rates, FX, Gold and silver
o Banking companies have to use own non-bank funds to trade riskier derivatives
o Fed assistance for derivative trading losses prohibited
➢ Bank Restrictions
o Commercial banking ops not allowed to trade in speculative investments; Allowed up to 3% of capital in private equity and hedge funds (Volcker Rule) - Total? Per Fund?
➢ Corporate Governance
o Non binding common vote on executive pay
o Fed can set standards on “excessive compensation that is unsafe and unsound”
➢ Rating Agencies
o Agencies must register with SEC; increased liability standards
• SEC to study practice of credit rating shopping
• SEC to determine if independent board is needed
➢ Mortgage Risk
o Lenders must obtain proof from borrowers regarding income / repayment capacity
o Lenders must disclose max amount that borrowers could pay on ARMs
o Lenders banned from incentives to push people into high priced loans
➢ Insurance
o New Office of National Insurance with Treasury
• Monitor industry
• Coordinate international insurance issues
• Identify issues that would lead to systemic crisis
I say
- Could be better, but could have been much worse
- The proof is in the eating
➢ Oversight
o Financial Services Oversight Council
• Monitors financial markets
• Powers to determine tougher regulations across some institutions
• Power to break up large financial firms if they are deemed to pose a “threat”
➢ Consumer Protection
o Within Federal Reserve
o Power over credit cards, mortgages and loans
• Auto dealers exempt
• Regulators can appeal council by a veto 2/3 vote
• Case by case actions
➢ Federal Reserve
o Retains supervision over bank-holding companies
o Polices large interconnected non-bank institutions based on oversight council determination
o With council approval, power to break up large financial firms
o To be audited by Congress’s investigative arm for emergency lending around 2008 crisis.
• Low cost loans Fed provides to banks, and securities actions will be audited.
➢ Bank Capital Standards
o Higher risk and size based capital standards for Banks with more than $250 bio in assets
o Certain hybrid securities no longer to be considered Tier 1 capital
o Banks < $15 bio retain trust preferred securities, while large banks must phase them out
➢ Derivatives
o Majority to be on a regulated public exchange. Banks must spin off swaps/swap shops?
o Banks can continue to trade derivatives related to interest rates, FX, Gold and silver
o Banking companies have to use own non-bank funds to trade riskier derivatives
o Fed assistance for derivative trading losses prohibited
➢ Bank Restrictions
o Commercial banking ops not allowed to trade in speculative investments; Allowed up to 3% of capital in private equity and hedge funds (Volcker Rule) - Total? Per Fund?
➢ Corporate Governance
o Non binding common vote on executive pay
o Fed can set standards on “excessive compensation that is unsafe and unsound”
➢ Rating Agencies
o Agencies must register with SEC; increased liability standards
• SEC to study practice of credit rating shopping
• SEC to determine if independent board is needed
➢ Mortgage Risk
o Lenders must obtain proof from borrowers regarding income / repayment capacity
o Lenders must disclose max amount that borrowers could pay on ARMs
o Lenders banned from incentives to push people into high priced loans
➢ Insurance
o New Office of National Insurance with Treasury
• Monitor industry
• Coordinate international insurance issues
• Identify issues that would lead to systemic crisis
I say
- Could be better, but could have been much worse
- The proof is in the eating
Wednesday, June 23, 2010
Book Excerpt: Chasing Goldman Sachs
I want to offer up the following, which is a Book Excerpt (June 22, 2010, 12:51PM EST) that I caught on Bloomberg.com....
....I have been quoted extensively in this piece, and offer it to you with a loud “No Comment”.
Having said that, would love to see your comments and opinions
Book Excerpt: Chasing Goldman Sachs
In an edited excerpt from her new book, Suzanne McGee writes about the inherent tension between risk managers and bankers
http://www.businessweek.com/managing/content/jun2010/ca20100622_618974.htm
....I have been quoted extensively in this piece, and offer it to you with a loud “No Comment”.
Having said that, would love to see your comments and opinions
Book Excerpt: Chasing Goldman Sachs
In an edited excerpt from her new book, Suzanne McGee writes about the inherent tension between risk managers and bankers
http://www.businessweek.com/managing/content/jun2010/ca20100622_618974.htm
Saturday, June 5, 2010
Just wrapping up a trip to Hong Kong and Macao where I spoke at Citibank’s Asia-Pacific Banks Conference on “Managing Risk in the New World”. A wide spectrum of Asian banks was represented in this excellent conference hosted by Citi’s Global Transaction Services business.
My theme is loudly that of keep-it-simple and back-to-basics, and it is time we re-discovered a strong common sense approach to financial markets and risk. Fear and greed remain key drivers of most of our crises, although to quote a former SEC chief “to blame greed for the financial crisis is like blaming gravity for a plane crash” !
Models don’t kill markets, people do. Let’s definitely not blame rogue models for landing us where we are now. It is time to do more on stress-testing and concentrations-analysis, and to form a much better understanding of liquidity and correlations than we do now. And it is more than time to become humble, as a clan whether you are a trader or a lender, a rating agency or a regulator, an economist or a risk manager!
Speaking of stress-testing, there continues to be a huge clamor for more discussion on this market-wide. Nobody really has this right, and while everybody seems able to do a good power-point presentation on the subject, the brass tacks are really tough. I am speaking more about scenario analysis & stress-testing than ever before, at a wide range of forums. More on this later, and on VaR, Risk-Appetite, Capital, Liquidity...there is much to talk about, and a good crisis not to allow to be wasted
Meanwhile, I have persuaded my good friend Aditya Rana in Hong Kong (ex-Citi, Morgan Stanley, AIG Financial Products) to put his increasingly popular newsletter on this site. Watch for this. I promise you something really worth the read. Watch also for Vikram Malkani’s (Citi, Lighthouse) post coming up.
Talk to you again soon ….
My theme is loudly that of keep-it-simple and back-to-basics, and it is time we re-discovered a strong common sense approach to financial markets and risk. Fear and greed remain key drivers of most of our crises, although to quote a former SEC chief “to blame greed for the financial crisis is like blaming gravity for a plane crash” !
Models don’t kill markets, people do. Let’s definitely not blame rogue models for landing us where we are now. It is time to do more on stress-testing and concentrations-analysis, and to form a much better understanding of liquidity and correlations than we do now. And it is more than time to become humble, as a clan whether you are a trader or a lender, a rating agency or a regulator, an economist or a risk manager!
Speaking of stress-testing, there continues to be a huge clamor for more discussion on this market-wide. Nobody really has this right, and while everybody seems able to do a good power-point presentation on the subject, the brass tacks are really tough. I am speaking more about scenario analysis & stress-testing than ever before, at a wide range of forums. More on this later, and on VaR, Risk-Appetite, Capital, Liquidity...there is much to talk about, and a good crisis not to allow to be wasted
Meanwhile, I have persuaded my good friend Aditya Rana in Hong Kong (ex-Citi, Morgan Stanley, AIG Financial Products) to put his increasingly popular newsletter on this site. Watch for this. I promise you something really worth the read. Watch also for Vikram Malkani’s (Citi, Lighthouse) post coming up.
Talk to you again soon ….
Monday, May 24, 2010
Welcome again, to J-Risk Advisors., and our Blog Spot !
In beginning this series, I am hoping to resume where I last left off on GARP Risk Exchange, the blog post of the Global Association of Risk Professionals.
I do not want to do this on my own – please help create a forum to talk about Risk, make your comments, write your blogs, and otherwise help us maintain an active dialogue; which of course (or the lack thereof) is in many, many ways the key takeaway from the recent / current financial crisis - at least insofar as where did Risk Management itself fail …… in Communication.
Risk Management communication may be about any and all of
- I am my brother’s keeper and coach, catalyst, ambulance driver, cop
- Trust but Verify
- Not just ‘what’, also especially ‘so what’
- Forests and Trees
- If the report were 1 page instead of 10, somebody would read it; and get it
- Judgment and experience, and not just model outputs
- Leave the Greeks alone (they have their own problems!)
Meanwhile, The Time has come …. To talk of many Things …..
We will open up soon on the Financial Reform brouhaha, VaR, Stress-Testing, Liquidity, Capital, the next big crisis, Leverage, Systemic Risk, Operational Risk and a lot more….
Watch this space …. and help fill it !!
Jaidev
www.j-risk.com
I do not want to do this on my own – please help create a forum to talk about Risk, make your comments, write your blogs, and otherwise help us maintain an active dialogue; which of course (or the lack thereof) is in many, many ways the key takeaway from the recent / current financial crisis - at least insofar as where did Risk Management itself fail …… in Communication.
Risk Management communication may be about any and all of
- I am my brother’s keeper and coach, catalyst, ambulance driver, cop
- Trust but Verify
- Not just ‘what’, also especially ‘so what’
- Forests and Trees
- If the report were 1 page instead of 10, somebody would read it; and get it
- Judgment and experience, and not just model outputs
- Leave the Greeks alone (they have their own problems!)
Meanwhile, The Time has come …. To talk of many Things …..
We will open up soon on the Financial Reform brouhaha, VaR, Stress-Testing, Liquidity, Capital, the next big crisis, Leverage, Systemic Risk, Operational Risk and a lot more….
Watch this space …. and help fill it !!
Jaidev
www.j-risk.com
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