This story is going to become bigger and bigger as more false denials come out. This is also fascinating as to how it relates to Canadian banks and how up to this point they have escaped much of the mess at American and European banks. I have to tip my hat both to Reuters and to ZeroHedge blog for getting this out. If you have funds in the stock market (401k, Roth IRA, Traditional IRA) you need to be aware of this and take due caution as it relates to your individual situation. Rehypothecation is basically (my laymen's definition) committing the same assets (which may be garbage "assets" to begin with) as collateral on different loans, or more than once.
http://www.zerohedge.com/news/denials-begin-interactive-brokers-first-claim-it-has-not-engaged-commingling-rehypothecation
Also, the original Reuters article again:
http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/
Showing posts with label derivatives. Show all posts
Showing posts with label derivatives. Show all posts
Sunday, December 11, 2011
Thursday, July 7, 2011
Satyajit Das Talking To Bloomberg
Derivatives expert Satyajit Das talks with Rishaad Salamat on Bloomberg TV
Wednesday, October 27, 2010
The Volcker Rule (As Written By Barney Frank and Frank Dodd) Is a Complete Joke and a Complete Sham
See how Frank Dodd (due to being one of the biggest cowards to walk the floor of the U.S. Senate) and Barney Frank have made a complete joke out of the Volcker Rule (because in fact is is not the Volcker Rule in its pure form). Commentary by Michael Lewis of Bloomberg
Thursday, February 25, 2010
Federal Reserve Unsuccessful in Prodding Swaps Dealers To Agree With Clearinghouse Goal
Bloomberg has a nice piece of journalism co-written by Shannon Harrington and Matthew Leising. It helps illuminate the behind the scenes quagmire between regulators and CDS (credit default swaps) investors to lower risk in the $25 trillion CDS market (yes, trillion with a T).
Many of the big players in the market (many of which are hedge funds) refuse to agree to specific goals before the Federal Reserve Bank of New York's March 1 deadline, in which they must define the industry's process by which they will move swaps through clearinghouses. These talks are currently "private" or behind closed doors.
The New York Federal Reserve Bank was "prodding" (NYFRB "prodding" is probably something close to what most people consider a love smooch) Goldman Sachs, JPMorgan Chase, and Deutsche Bank AG and other swaps dealers into clearing 90% of the eligible trades by 2009. The investment banks' clients are fighting against this (clearing trades) because it would cost them more.
After the sudden collapse of AIG and Bear Stearns and the bankruptcy of Lehman Brothers (in other words after all the damage had been done) the Federal Reserve "demanded" the industry start clearing the derivatives trades. Although asset managers somewhat backed broader use of clearinghouses, they wanted assurances that clearing trades would also come with some bankruptcy laws protecting the trades. They are also worried about extra collateral costs. An example the Bloomberg article gives is hedge funds often use trades that take advantage of "price dislocations" between index contracts and swaps on companies included in the index. Prime brokers will demand collateral on the net amount at risk from offsetting trades.
The problem (supposedly) is cash can get tied up in one part of the trades, affecting other trades, and here I will just quote directly from Harrington and Leising's story:
In essence credit default swaps (my words here) are a type of insurance which people can buy, which pays if a company (or sometimes a country's government) doesn't pay off its debts (maybe debts on bonds or loans). Derivatives ideally are used to "hedge" against risks or protect from extreme downsides. There are two leading clearinghouses now, one in Chicago and one in Atlanta mostly involved in contracts tied to credit indexes.
There are ongoing negotiations between the New York Federal Reserve (NYFRB). The negotiations participants include 15 dealers, 9 investment firms, and 3 trade associations. They are trying to resolve obstacles to a higher percentage of swap contracts being traded through clearinghouses. The New York Fed, PIMCO, and other negotiation participants declined to comment at this stage.
The situation (with negotiations) is probably summed up best by the Chief Operating Officer of BlueMountain hedge fund, Samuel Cole, who I quote directly from the Bloomberg article here:
In other words, dealers are making plenty of money now, and have power in the market, and want things to stay status quo, even if the rest of us have to suffer.
Many of the big players in the market (many of which are hedge funds) refuse to agree to specific goals before the Federal Reserve Bank of New York's March 1 deadline, in which they must define the industry's process by which they will move swaps through clearinghouses. These talks are currently "private" or behind closed doors.
The New York Federal Reserve Bank was "prodding" (NYFRB "prodding" is probably something close to what most people consider a love smooch) Goldman Sachs, JPMorgan Chase, and Deutsche Bank AG and other swaps dealers into clearing 90% of the eligible trades by 2009. The investment banks' clients are fighting against this (clearing trades) because it would cost them more.
After the sudden collapse of AIG and Bear Stearns and the bankruptcy of Lehman Brothers (in other words after all the damage had been done) the Federal Reserve "demanded" the industry start clearing the derivatives trades. Although asset managers somewhat backed broader use of clearinghouses, they wanted assurances that clearing trades would also come with some bankruptcy laws protecting the trades. They are also worried about extra collateral costs. An example the Bloomberg article gives is hedge funds often use trades that take advantage of "price dislocations" between index contracts and swaps on companies included in the index. Prime brokers will demand collateral on the net amount at risk from offsetting trades.
The problem (supposedly) is cash can get tied up in one part of the trades, affecting other trades, and here I will just quote directly from Harrington and Leising's story:
"If one leg of the trade were required to be cleared, while the other contracts aren’t eligible, fund managers may be forced to increase the amount they have to post, tying up cash, the people said.The New York Fed has led regulators including the U.S. Securities and Exchange Commission, the Commodity Futures Trading Commission, the U.K.’s Financial Services Authority and Germany’s Federal Financial Supervisory Authority in seeking increased transparency and less risk from over-the-counter derivatives markets. Some $605 trillion in contracts were outstanding at the end of June 2009, according to the Bank for International Settlements.Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on or hedge a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements."
In essence credit default swaps (my words here) are a type of insurance which people can buy, which pays if a company (or sometimes a country's government) doesn't pay off its debts (maybe debts on bonds or loans). Derivatives ideally are used to "hedge" against risks or protect from extreme downsides. There are two leading clearinghouses now, one in Chicago and one in Atlanta mostly involved in contracts tied to credit indexes.
There are ongoing negotiations between the New York Federal Reserve (NYFRB). The negotiations participants include 15 dealers, 9 investment firms, and 3 trade associations. They are trying to resolve obstacles to a higher percentage of swap contracts being traded through clearinghouses. The New York Fed, PIMCO, and other negotiation participants declined to comment at this stage.
The situation (with negotiations) is probably summed up best by the Chief Operating Officer of BlueMountain hedge fund, Samuel Cole, who I quote directly from the Bloomberg article here:
“The dealer community may be filibustering to protect its oligopoly and not seriously engaged in working with the buy side to develop a clearing solution,”
In other words, dealers are making plenty of money now, and have power in the market, and want things to stay status quo, even if the rest of us have to suffer.
Saturday, February 20, 2010
Mathematical Models Used In Finance: Help or Hindrance??
Normally I don't like to use stories from the British based magazine "The Economist" because they have an extremely asinine policy of not giving credit to writers on individual stories. Indeed this will hurt them because all writers and journalists will hate them in their heart-of-hearts for this misguided and dictatorial way, but I digress about the Hugo Chavez style editorial policy.... The person/persons who wrote the article (who wrote it is something they feel their readers aren't entitled to know) entitled "Number-crunchers Crunched" did a good job.
The article starts off by noting Black-Scholes model was first used by options traders in the mid-1970s. Initially, when the Black-Scholes model was used it might have seemed emasculating to some in the macho world of options trading (at least as done on the floors of exchanges then). But as it proved successful it came to be used by most traders. Derivatives trading got a shot in the arm from Black-Scholes and over time more "quants" entered the finance and trading field.
Over time though (most obvious with the economic crisis of 2008-2009) these models didn't prove to be so dependable, and many people believe that the unregulated derivatives market, collateralised debt obligations (CDOs), and credit default swaps (CDSs) were the root cause of this crisis. "The Economist" article states (I paraphrase here) that the math models were useful for interest rates and foreign exchange, but were a total failure in debt markets, where the mathematical models proved to have zero prognosticating function when it came to the collapse of the housing market.
Bankers took low-quality mortgage-backed securities and bundled them together with supposedly higher quality debt securities (combining different classes or "tranches" of debt). These different classes of
quality debt securities that were packaged together were then labeled CDOs and stamped with a AAA rating. Credit ratings agencies (such as Moody's) were more than happy to appease the investment banks who paid them. Financial firms chose to rely on those models, even though they full well knew that the expected rates of return were unrealistically high for the so-called "AAA" rated securities. Some risk managers were even fired from their jobs for questioning the realism of the models (Does the name Iris Mack come to mind??). No matter how wacky the risk vs. expected return the models showed were, Moody's and S&P models were not to be questioned, afterall as "The Economist" article quotes a regulator saying "A lifetime of wealth was only one model away".
Also, the rampant use of these models probably impacted markets in such a way as to create a sort of "feedback loop" where the models detrimentally affected their (the models') own function to predict. This feedback process is sometimes termed counter-performativity, which usually occurs when a mathematical model used in the markets becomes so popularly used it then has a negative affect on itself. It's important to note that this counter-performativity was not a root cause of problems, but one of the many smaller factors to consider.
As the article rightly notes, and I quote here directly from the article (referring here to the mathematical models):
The banks were trying to "unwind" the same positions (same types of securities) at the same time. Which of course added an enormous amount of uncertainty/risk during the peak of the crisis.
Models used for stress tests
The article then goes on to discuss different type models used for stress tests. There are 3 types stress tests this article discusses:
1. VAR "value-at-risk"
2. Conditional VAR (CoVAR)
3. "stress" VAR
These tests can be used to judge a portfolio of assets, or by regulators looking at banks' quality of capital reserves (the banks' capital "buffers" in times of calamity). The VAR was invented by some brainiac types at JPMorgan in the late 1980s. VAR and its descendants have since become very popular at banks. Bank regulators seem to favor CoVar style tests more because CoVAR accounts more for spillover affects in bad markets and "counterparty risks"---the distress of others you deal directly with. CoVAR would give a worse picture of the future, but CoVAR is more realistic during times of major trouble. "Stress"VAR which Morgan Stanley uses, factors in liquidity much more (possible scenarios where liquidity is very tight).
Some banks systems seemed to be more dysfunctional than others. For example Citigroup was using many different "legacy" systems (computers, etc...) because of many past mergers. Also different units (subsidiaries) of the same large banks may have used different data inputs into the same models, therefor even inside the same bank, units would come up with different measures of risks.
Some Solutions to Finance Models' Downsides
1. More reliance on solid and prudent judgement, less reliance on numbers.
2. Using stricter stress tests (such as CoVAR) which rely on more capital buffers and more margin of safety.
3. Synchronizing of IT systems between different units (subsidiaries) and making sure the better information spit out by the IT system makes its way to senior management's eyeballs.
4. "Model-uncertainty reserves". JPMorgan Chase now holds $3 billion of these such reserves.
"The Economist" article (writer unknown) has more details I didn't include here. I encourage those interested to go there.
The article starts off by noting Black-Scholes model was first used by options traders in the mid-1970s. Initially, when the Black-Scholes model was used it might have seemed emasculating to some in the macho world of options trading (at least as done on the floors of exchanges then). But as it proved successful it came to be used by most traders. Derivatives trading got a shot in the arm from Black-Scholes and over time more "quants" entered the finance and trading field.
Over time though (most obvious with the economic crisis of 2008-2009) these models didn't prove to be so dependable, and many people believe that the unregulated derivatives market, collateralised debt obligations (CDOs), and credit default swaps (CDSs) were the root cause of this crisis. "The Economist" article states (I paraphrase here) that the math models were useful for interest rates and foreign exchange, but were a total failure in debt markets, where the mathematical models proved to have zero prognosticating function when it came to the collapse of the housing market.
Bankers took low-quality mortgage-backed securities and bundled them together with supposedly higher quality debt securities (combining different classes or "tranches" of debt). These different classes of
quality debt securities that were packaged together were then labeled CDOs and stamped with a AAA rating. Credit ratings agencies (such as Moody's) were more than happy to appease the investment banks who paid them. Financial firms chose to rely on those models, even though they full well knew that the expected rates of return were unrealistically high for the so-called "AAA" rated securities. Some risk managers were even fired from their jobs for questioning the realism of the models (Does the name Iris Mack come to mind??). No matter how wacky the risk vs. expected return the models showed were, Moody's and S&P models were not to be questioned, afterall as "The Economist" article quotes a regulator saying "A lifetime of wealth was only one model away".
Also, the rampant use of these models probably impacted markets in such a way as to create a sort of "feedback loop" where the models detrimentally affected their (the models') own function to predict. This feedback process is sometimes termed counter-performativity, which usually occurs when a mathematical model used in the markets becomes so popularly used it then has a negative affect on itself. It's important to note that this counter-performativity was not a root cause of problems, but one of the many smaller factors to consider.
As the article rightly notes, and I quote here directly from the article (referring here to the mathematical models):
"They failed Keynes's test that it is better to be roughly right than exactly wrong."
The banks were trying to "unwind" the same positions (same types of securities) at the same time. Which of course added an enormous amount of uncertainty/risk during the peak of the crisis.
Models used for stress tests
The article then goes on to discuss different type models used for stress tests. There are 3 types stress tests this article discusses:
1. VAR "value-at-risk"
2. Conditional VAR (CoVAR)
3. "stress" VAR
These tests can be used to judge a portfolio of assets, or by regulators looking at banks' quality of capital reserves (the banks' capital "buffers" in times of calamity). The VAR was invented by some brainiac types at JPMorgan in the late 1980s. VAR and its descendants have since become very popular at banks. Bank regulators seem to favor CoVar style tests more because CoVAR accounts more for spillover affects in bad markets and "counterparty risks"---the distress of others you deal directly with. CoVAR would give a worse picture of the future, but CoVAR is more realistic during times of major trouble. "Stress"VAR which Morgan Stanley uses, factors in liquidity much more (possible scenarios where liquidity is very tight).
Some banks systems seemed to be more dysfunctional than others. For example Citigroup was using many different "legacy" systems (computers, etc...) because of many past mergers. Also different units (subsidiaries) of the same large banks may have used different data inputs into the same models, therefor even inside the same bank, units would come up with different measures of risks.
Some Solutions to Finance Models' Downsides
1. More reliance on solid and prudent judgement, less reliance on numbers.
2. Using stricter stress tests (such as CoVAR) which rely on more capital buffers and more margin of safety.
3. Synchronizing of IT systems between different units (subsidiaries) and making sure the better information spit out by the IT system makes its way to senior management's eyeballs.
4. "Model-uncertainty reserves". JPMorgan Chase now holds $3 billion of these such reserves.
"The Economist" article (writer unknown) has more details I didn't include here. I encourage those interested to go there.
Friday, February 19, 2010
Registered Exchanges For Derivatives and Vanilla Flavored Swaps
Mike Konczal and James Kwak are my two favorite business bloggers. And Mike Konczal is arguably the best internet writer on issues directly related to finance. His latest post relates to derivatives markets reforms which could make the world (at least America) a much safer place to do business and keep a bank account. Although I don't keep money at banks myself, I only keep my money at credit unions because credit unions are safer and offer better interest rates, but that's another story/post. But anyone who cares about the safety of the American financial system should read Mike Konczal's latest post. He also quotes Rick Bookstaber who has a financial blog that is worth checking out at this web address. I've recently added Rick Bookstaber to my blogroll so you can check him out any time here, just click on the link in the right margin.
Saturday, January 30, 2010
Does Warren Buffett Condone Bad Accounting??? / Is Warren Buffett a Hypocrite???
This story I found sifting through Tyler Durden's site ZeroHedge. Tyler has a terrific site for those who focus on finance and daily market activity. The original story (commentary) was taken from Jonathan Weil over at Bloomberg. It discusses the way that Wells Fargo records derivatives on their balance sheet. If you follow Warren Buffett like a little crowd mentality robot (which many market participants have done for years) you would already know that Warren Buffett owns 313 million shares of Wells Fargo (ticker WFC).
I admit for many years I was among that crowd who read some of Buffett's words in magazines and books and at one time I had respect for him. But as you follow him over many years you would discover he is not so much for the "little guy" as he tries so hard to portray himself. And being that Warren Buffett watches balance sheets extremely closely and minutely, you might guess that Buffett has at the least condoned or maybe even encouraged this type of accounting at Wells Fargo. Don't shareholders (big and small) have a right to know what is going on here with the way Wells Fargo records derivatives on their balance sheets???----especially when it seems to be done in an extremely misleading and deceptive way. If I went to the next Berkshire Hathaway meeting, you can rest assured it would be the first question I would ask Warren Buffett. The very next question out of my mouth would be "Warren, do you also condone the breaking of FASB accounting rules?? Because that is what Wells Fargo has done here."
I guess (it certainly seems) Warren Buffett really isn't that different than the crazy derivatives traders/dealers in his heart of hearts. He thinks it's ok to trade or purchase extremely risky derivatives as long as they're labeled "hedges" on the bank's balance sheet.
Update: Reggie Middleton does an update and digs into further detail on the Wells Fargo accounting shenanigans/ bullshit. This is a quick read and a must read especially for Wells Fargo investors, and value investors in general. Seems as Mr. Buffett might say, Wells Fargo stock is highly "overvalued" at this juncture.
I admit for many years I was among that crowd who read some of Buffett's words in magazines and books and at one time I had respect for him. But as you follow him over many years you would discover he is not so much for the "little guy" as he tries so hard to portray himself. And being that Warren Buffett watches balance sheets extremely closely and minutely, you might guess that Buffett has at the least condoned or maybe even encouraged this type of accounting at Wells Fargo. Don't shareholders (big and small) have a right to know what is going on here with the way Wells Fargo records derivatives on their balance sheets???----especially when it seems to be done in an extremely misleading and deceptive way. If I went to the next Berkshire Hathaway meeting, you can rest assured it would be the first question I would ask Warren Buffett. The very next question out of my mouth would be "Warren, do you also condone the breaking of FASB accounting rules?? Because that is what Wells Fargo has done here."
I guess (it certainly seems) Warren Buffett really isn't that different than the crazy derivatives traders/dealers in his heart of hearts. He thinks it's ok to trade or purchase extremely risky derivatives as long as they're labeled "hedges" on the bank's balance sheet.
Update: Reggie Middleton does an update and digs into further detail on the Wells Fargo accounting shenanigans/ bullshit. This is a quick read and a must read especially for Wells Fargo investors, and value investors in general. Seems as Mr. Buffett might say, Wells Fargo stock is highly "overvalued" at this juncture.
Tuesday, January 12, 2010
Professor Jayanth Varma On Derivatives Regulation
If you have not visited or know of Jayanth Varma and his terrific blog, you need to go and visit NOW. He has one of the most underrated finance blogs on the internet. Very informative and well written.
Professor Varma's most recent post deals with the topic of Clearinghouses vs. Registered Exchanges. It also has some outstanding links inside his post. Darrel Duffie and two co-authors have a terrific paper written on the topic. I could put the links here now, but I want you to GO VISIT HIS SITE!!!!!
I strongly believe that registered exchanges are NECESSARY for derivatives trading. Letting Clearinghouses do it is letting the dealers/traders to regulate themselves. As Alan Greenspan so painfully taught us with the systemically threatening banks, SELF-REGULATION DOES NOT WORK.
So even if you feel you know this topic well, I 'm sure you can learn more with Professor Varma and his links.
Update: We also know self-regulation doesn't work by looking at Larry Summers' double chin.
Professor Varma's most recent post deals with the topic of Clearinghouses vs. Registered Exchanges. It also has some outstanding links inside his post. Darrel Duffie and two co-authors have a terrific paper written on the topic. I could put the links here now, but I want you to GO VISIT HIS SITE!!!!!
I strongly believe that registered exchanges are NECESSARY for derivatives trading. Letting Clearinghouses do it is letting the dealers/traders to regulate themselves. As Alan Greenspan so painfully taught us with the systemically threatening banks, SELF-REGULATION DOES NOT WORK.
So even if you feel you know this topic well, I 'm sure you can learn more with Professor Varma and his links.
Update: We also know self-regulation doesn't work by looking at Larry Summers' double chin.
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