PrefBlog

The bond insurance business gets more interesting every day! Naked Capitalism has two pieces on it today, the first attempting to quantify the problem:

Bill Ackman of hedge fund Pershing Square has gotten a considerable amount of flack for his outspoken, negative views of the bond insurers, particularly MBIA and Ambac, which his firm has shorted. Ackman has been circulating a detailed analysis that estimates that the additional equity needed to maintain an AAA rating at the two biggest firms is roughly $15 billion.

This calculation is sharply contested by new rating agency Egan Jones (which also downgraded MBIA to a B+, a junk rating) which says the industry needs more than an order of magnitude more capital, namely $200 billion.

Egan-Jones was mentioned in PrefBlog on November 7. As a subscription-based credit advisor, they have an interest in saying exciting things … which is not to say they’re wrong, of course, but it is something to keep in mind. They received NRSRO status in December.

Naked Capitalism also takes a rather gloomy view of the New York Insurance Regulator’s bail-out facilitation – even gloomier than the one I remarked on yesterday. Until shown otherwise, I’m just going to assume the whole NY bail-out thing is plain-and-simple grandstanding … Mr. Dinallo, the head of the NY regulator, learned all about grandstanding in his last regulatory job:

Superintendent Dinallo served at the Office of Attorney General Eliot Spitzer from 1999 to 2003. As Chief of the Securities Bureau, he was charged with combining that bureau with the Real Estate Finance Bureau. The resulting Bureau was named the Investment Protection Bureau to reflect its focus, and Mr. Dinallo was named its first Chief. In that capacity, he led the reinvigorated Bureau’s investigations into the Wall Street Cases – conflicts of interest in the financial services industry, including research analyst cases and the spinning of hot initial public offerings. He produced more than 40 major civil and criminal matters, and led the Bureau through the beginning of the mutual fund industry investigations.

However, Barclays Capital has opined that there may be very serious knock-on effects should the insurers fail:

Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital.

Banks will need at least $22 billion if bonds covered by insurers led by MBIA Inc. and Ambac Assurance Corp. are cut one level from AAA, and six times more for downgrades by four steps to A, Paul Fenner-Leitao wrote in a report published today. Barclays’ estimates are based on banks holding as much as 75 percent of the $820 billion of structured securities guaranteed by bond insurers.

I will have to do some more research into the bank capital regulations … it seems to me that having such levels of exposure to single names should attract a concentration charge on capital … I’m honestly not sure whether or not it does.

And Naked Capitalism draws to my attention (very good crop today, Yves!) an opinion piece by Willem Buiter, who is something of a regular on this blog:

Even with a few days worth of hindsight, the Fed’s out-of-sequence, out-of-hours 75 basis points cut in the target for the Federal Funds rate continues to look extraordinary and deeply misguided. Indeed, it looks less and less like a decisive pre-emptive move in response to unexpected bad news designed to meet the Fed’s triple mandate of maximum employment, stable prices and moderate long-term interest rates, than a knee-jerk panic reaction to a global stock market collapse.

Did the sharp global decline in stock values at the beginning of this week reflect a rational re-assessment of fundamentals? The only two candidate explanations I have heard are (a) that the collapse was probably triggered by concerns about the financial viability of the monolines and (b) that it was intensified by the unwinding by SocGen of the long equity positions taken by its employee of the year (not!). I find neither explanation convincing. If the collapse was a spurious, non-fundamental event, there is no reason for the Fed to react to it. The ability of the Fed to meet its fundamental objectives is seriously undermined if it is perceived as the poodle of the equity markets.

So sign up another member of the “But what about inflation?” camp.

Assiduous Readers will be familiar with my grumpiness about US Fiscal policy – the last six years have been permanent stimulation – but I’m in good company:

[Harvard Professor Jeffrey Frankel] explains:

“In 2001, very aggressive monetary and fiscal expansion reduced the severity and length of the recession. It is true that this time as well the Fed has been busy cutting interest rates and the government is working on a fiscal stimulus. But this time, before long, our policy makers will run into constraints. The government can’t keep cutting taxes, because the national debt is too high, the path of future deficits too steep, and the costs of the baby boomers’ retirement too imminent. The federal government needs to retain the confidence of the bond markets.

“This is different from 2001, which we entered with a record budget surplus, allowing room for stimulus. Similarly, the Fed can’t keep cutting interest rates because the dollar has been falling steeply, and America needs to retain confidence of foreign investors who are financing our deficits. This is different from 2001, when the dollar was strong, inflation was all but dead, and the Fed could cut interest rates by [5.5 percentage points].”

A few more details – and a bit more rational commentary – is emerging regarding the SocGen stock futures fiasco:

But a top French presidential advisor revealed that Kerviel had positions of more than 50 billion euros (73 billion dollars) — more than the bank’s current market capitalisation of 35.9 billion euros.
…
Many experts said it was difficult to believe a lone trader could have successfully hid such colossal losses.”

“The feeling in the dealing rooms is that it is not possible for an individual to do all that. They think Societe Generale has overdone the fraud to cover up some bad market operations,” said Elie Cohen, an economy professor and research director for the National Centre for Scientific Research (CNRS).

One example of such feelings as were noted by Elie Cohen is:

Let’s get this straight: the MainSwamp media (who are such profoundly ignorant whip-kissers that they think that the wankfest at Davos is worth reporting on) would have you believe that a single trader whose entire remuneration package (including bonuses) was 100k euro, had such free rein that he could rack up positions with aggregate losses of A$9 bill, with nobody noticing. (To get to an aggregate loss of A$9 bill, you need an actual position larger than that, no?)

A bank with owners equity of about $20 billion, and its processes are so poor that such a thing could happen? The Banque de France – who audits every bank every year, and knows if an individual Frenchman passes a bad cheque – knew nothing of it?

Sorry lads – no sale.

What has happened here, I bet, is that SocGen has found an internal culprit, and is hanging as large an amount on him as they think they can get away with. So this geezer might have sent $100 mill to Money Heaven – that amount could possibly be hidden for a week or so – and the Bank has used him as a scapegoat and has attributed half its subprime-related losses to him rather than the subprime book.

… and a bit more delicately:

“That’s when he made his first mistake,” said Jean-Pierre Mustier, head of investment banking at Societe Generale. “He no longer knew the type and calendar of the controls.”

The trading loss raises questions about the bank’s risk management procedures.

“I find it really improbable that this trader was not abetted by at the very least incompetence, if not assistance from others,” said Joseph Mason, a risk-management researcher and professor of finance at Drexel University in Philadelphia. “Ultimately, we’re talking about a breakdown of fundamental operational controls.”

“Calendar of the controls”? No wonder SocGen’s lost so much. And finally (hat tip: Financial Webring Forum), Jim Sinclair reviews the data and offers the opinion:

The USD $7,000 million loss reported as an action of a junior trader hiding a losing position for a considerable amount of time as stated is total bull.

You would have to be totally IGNORANT of market mechanics to buy that plausible denial.

The public and much of the media are.

The reported loss was a buyout of a failed to or chosen not to perform derivative.

One theory regarding the mechanics of the scheme that has been suggested to me is that the trader was writing single puts on multiple futures/forward contracts rather than multiple puts on single futures/forward contracts, then fiddling with the documentation to make it look like one put = one contract, rather than the actual one put = multiple contracts.

Well, that may be. I responded that most cases like this aren’t very complicated, really. It’s usually just a matter of dumb stealing from dumber. Or, perhaps, dumber turning a blind eye, as long as dumb was making money.

I’ll admit, one thing that makes me a little nervous about the whole episode is the continued emphasis on his background in operations:

Kerviel drew on knowledge he acquired during six years in Societe Generale’s back office, where he went to work in 2000 after completing a degree in market operations at the University of Lyon II, according to an alumni Web page. He had to breach five levels of controls to get away with his trades, Bank of France Governor Christian Noyer said at a press conference yesterday.

His “intimate and perverse” knowledge of the bank’s controls let him avoid detection, co-Chief Executive Officer Philippe Citerne told reporters.

This is the type of thing that might make a particularly overbearing, paternalistic and incompetent regulator (please don’t cry, Assiduous Readers, some such do exist) forbid such transitions.

I came up through operations. It was while working in operations on starvation wages that I got interested in finance. The background has served me well … back-office bullshitters find I’m asking them questions they’d rather not answer, on occasion. I’m hardly alone in this; the traditional manner of becoming a trader is by first becoming a traders’ clerk – something I wish I’d know when I got my first full-time operations job and spent several years kicking myself for asking for the higher-paying dead-end choice.

But we’ll see.

There’s a new inhabitant of litigation-land!

this move by New York City and State to sue lead manager Goldman, 25 other underwriters and accounting firms over a Countrwide stock offering is routine securities fraud, in this case making misrepresentations about the company’s prospects. No one has yet to develop a legal theory to go after Goldman for the move that has many offended, being net short subprime related debt while continuing to sell them to investors. And the latter is unlikely to go anywhere (saver perhaps serving as fodder for Congressional investigations) because that action didn’t violate any securities laws.

There is no indication as yet as to whether the New York City and State portfolio managers have even been asked as to whether they did a due diligence.

Well folks …. sorry! Prices are not yet available from the TSX and I’m going out for dinner. I’ve been keeping the HIMIPref™ indices up to date, by the way, after cramming in the prices at odd hours, just not reporting them. But I’ll see what I can do over the weekend to – at least – get today’s index levels up.

This entry was posted on Friday, January 25th, 2008 at 9:17 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.