CHAOS-ONOMICS: Strangely Attracted to the Truth
May 6:
I think all traders have a tendency to fall into the same trap. You always have a way of recovering the loss. You either admit your loss, and lose face, or you wait a little: one month, two months, or however long it takes. - Iguchi Toshihide Daiwa Bank
Researching yesterday's submission to GATA on the Daiwa Bank scandal (below) led to a few more hours of reading and thinking, the fruits of which I thought to share today. I was surprised, having worked in an around the financial industry for some 16 years, at the ease with which scandal fades from my memory, particularly given my skeptical frame of mind. It was thus with delight that I came across Roy Davies' web site, sections of which are devoted to financial scandals. Reading through the list recalled the events back to life and inspired a sense of wonder that this collection of scandal has been successfully hidden from the public awareness as a cohesive whole. In hopes of illuminating the forest of scandal rather than the individual trees, lets look at Mr. Davies' list.
John Rusnak and AIB, Banco Ambrosiano and the Vatican Bank, BCCI, Nick Leeson and Barings Bank, Bre-X, Butcher Brothers and UAB, Cendant Corp, Credit Lyonnais, Toshihide Iguchi and Daiwa Bank, Dot.com bubble and investment banks, Enron and Arthur Anderson, Jardine Fleming, Martin Frankel, Joseph Jett and Kidder Peabody, Orange County, Metallgesellschaft, Morgan Grenfell, NatWest Markets, Lloyd's of London and the Insurance Industry, Maritime Fraud, The Savings and Loan or Thrifts Crisis, Robert Maxwell, Pension Funds, Mortgages, & Split Capital Investment Trust Scandals, Yasuo Hamanaka and Sumitomo Corp., WorldCom.
It is quite a list, including many of the "respected" names in finance and if memory serves, each time a scandal surfaced, the consensus reporting coalesced around the conclusion that the current incident was the exception to what in general was a well functioning machine. For most of the 25-odd years covered by the list, paper assets have performed quite well, which, recalling Warren Buffett's notion that one only finds out who has been swimming naked when the tide rolls out, makes me shudder to contemplate just how many scandals are still lurking underneath the radar, obscured by derivatives, false trades or other chicanery. What happens when the public desire for ever increasing amounts of paper assets shifts to a desire for tangibles?
William Leith, of the UK's Guardian, asks, why do they do it?, in How to lose a Billion. His conclusion, "it all starts the moment you make a bad trade and try to cover it up. You tap false figures into your computer and hope that you'll be able to make good the loss from a future trade." He goes on; "A rogue trader is not a crook in the normal sense of the word. He is someone who loses money and, in trying to pretend that he hasn't lost money, loses more. It's like a classic farce. For the trader, as Leeson says, it feels like being carried away by a hot-air balloon; if you don't jump off immediately, you can't jump off at all. Most people, finding themselves in this position, would jump off immediately. But rogue traders stay where they are; they try to trade their way out of trouble. As the trades get worse, the cover-ups get more complex. And, paradoxically, as the losses get bigger, the harder they get to spot - a loss of several hundred million is, in the eyes of a bank executive, much more likely to be a misprint."
Perhaps the association of rogue trader with these scandals is the key point disabling inquisitive souls from connecting these dots. Yet, the idea of a rogue seems a bit inconsistent in the sense that the rogue ness was rarely seen until the end, it tended to blend right in. Many of the scandals listed occurred over years and involved others, sometimes many others including bank management. The Enron/Arthur Anderson fiasco is a fine example of un-rogue ness, if you will, in that the malfeasance was widespread, yet the origins are, in my view, the same. Leeson and Rusnak shared a view with the boys from Enron and Worldcom. They all saw that most people accepted what they were told, presuming the usual rituals were followed and the tale was consistent with expectations. As demographics and turmoil conspire to test the popular faith in the financial markets, a fine example of Buffett's tide going out, I think the experimental policy change inspired by the baby boom, the broken link between money and Gold will come to be seen as a "rogue policy" which inspired a generation of ever more complex cover-ups attempting to prove its viability.
Turning to the focus of today's trading, the FOMC meeting, please examine today's graph. For most of his tenure, the Greenspan Fed can be seen to have followed a path of validating or adjusting market interest rate expectations as measured by the 2 year note. Given that most banks tend to borrow short and loan long the 2-yr/Fed Funds spread serves as a proxy for Fed inspired credit tightness. When this spread is over 1% the Fed is providing lots of liquidity to the banks and when the spread is -1% (rarely seen during Greenspan's days) the Fed is draining aggressively. By that metric the Fed has been mildly accommodative of late, validating the continued decline in 2-yr yields from the early 2000 peak.
Given recent US$ declines the balance of risks assessment may shed some light on Fed thinking on this issue. An easing bias suggests that the Fed is ready to let the US$ slide. More intriguing, although probably not likely to be a factor in today's deliberations is the question of when to turn this boat around. It has been a long ride down the curve but eventually rates will have to rise and we will finally get to see who has been swimming naked.
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memories of scandals past
This afternoon while contemplating a suitable topic for today's submission I received an email from the Federal Reserve terminating two enforcement orders against Daiwa Bank. These enforcement orders, the second of which was an order to terminate US Banking activities, were issued in relation to Iguchi Toshihide's cover-up of US bond trading losses of some US$1.1B, uncovered in 1995. This story, like those of Nick Leeson at Barings Bank or John Rusnak at AIB speaks volumes about the ease with which accounts can be manipulated to present a false picture of solvency readily accepted by superiors eager to share the "good news".
Embedded in these tragic stories of hubris is the faith that profits are the norm and not the exception. This can be seen in the "rouge" traders themselves, as they chose to hide their losses, in senior management, who accepted reports of the profits without proper audit and in banking regulators themselves, who failed to spot the losses over the course of years and in this specific case, tried to hide them in order to avoid any damage to the public's perception of Daiwa and Japanese Banks themselves.
I find the case of the Daiwa Bank scandal interesting in that it contains a scandal within a scandal. The enforcement orders whose termination notices recalled this case to my memory were issued not because one trader had hidden a loss but because, in the words of Mary Jo White, US Attorney for the Southern District of New York, "as charged in the Indictment, DAIWA and a number of its highest senior officials themselves committed crimes as they attempted to cover-up other crimes." Unmentioned in the criminal complaint is any reference to Toshihide's claim that Japan's Ministry of Finance was at least aware of the cover-up. Here, once again, we have evidence of senior management of a major bank conspiring to hide losses by any means possible, even selling customer assets, and perhaps with the help of some segments of their national financial authority. Yet the idea that other banks might be trying to conspire to manipulate the price of Gold perhaps with the help of national financial authorities is a non starter.
At some point in the future I think we will all look back at these cases as signs of something "rotten" in the game of finance. How can such enormous sums of money be lost, often over periods of years without more people being aware? In my view, it all begins with elastic money of indeterminate value. For now, however, the stories easily fade from market memory, secure in the faith that profits are the norm and prosperity just around the corner, which is exactly the breeding ground for further scandals. Who knows what other losses might be lurking in the ever growing labyrinths of derivative finance. |
