The custom derivatives business can be good money maker - IF:
1) You control the risk - offset the deals, don't over leverage, test against a wide selection of possible events, qualify your counterparties, etc.
Greenspan On derivative Risk:
"Except where market discipline is undermined by moral hazard - HAHA, owing, for example, to federal guarantees of private debt, private regulation generally is far better at constraining excessive risk-taking than is government regulation."
Now this the man that said S&L companies were A OK right before it all go BOOM! So he not so hot on timing or prediction I fear. Some PHD's even go so far as to accuse him of taking care of rich friends at the cost of little guy.
What was original purpose of federal reserve system? Why could the banks not police themselves? Why cant I leave my 5 year old alone or even my 15 year old? Or even my 70 year old grandma - cause they ALL GET IN TROUBLE without OVERSIGHT!!! I hear tom delay and others that should know better like martha and such all break LAW - so much for self regulation!
Warren:
"There is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives....[Total return swaps and] other types of derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions."
Risk Concentration:
Greenspan:
"One development that gives me and others some pause is the decline in the number of major derivatives dealers and its potential implications for market liquidity and for concentration of counterparty credit risk."
Warren:
"Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one another."
2) As the prime broker, GS gets to make the risk calculations and loan the margin money. They get to play the game AND be score keeper.
Isn't self regulation wonderful ? ;-)
No it is terrible for me and you! I again ask you to explain to me why warren buffet say federal reserve system was created in the first place - if the industry could self regulate and this was superior - why dont we let banks do it? Why dont we fire SEC and all other government bodies - self regulation so good right?
By the way, outside of listed options, I don't play in the derivatives business. It makes my head hurt, and it is far too much like real work.
It make many heads hurt I am sure, I read the following article about PRIME BROKERS and it make my head hurt more!
stwr.net
The Financial Times recently quoted a spokesperson for The Centre For The Study Of Financial Innovation who described the business of 'prime brokerage services' conducted by the world's biggest banks as, "the crack cocaine of the financial system." For the uninitiated, prime brokerage services are the basic services banks offer fund managers in return for commission dollars. (Hedge funds are multi-purpose funds that can do any arcane, risky, cross-market speculative thing with their money they want to – imagine a financial kama sutra where every dollar of opportunity is slotted into every conceivable orifice of the globe's financial organs).
It's hard to imagine prime brokerage services as crack cocaine. It's plain vanilla stuff, really; one-stop shopping for hedge fund who want various generic banking services like lending money, buying and selling securities, and book keeping, so you would think there wouldn't any cause for panic, but according to the FT, prime brokerage services are the unstable sea bed that is starting to shift beneath our world with the displacement of trillions of dollars worth of unregulated, unsupervised, unstable financial products that are overdue for a "once in 1,000 years" disaster.
For ecologists who are used to thinking of the globe's eco-problems in terms of parts-per-million of carbon in the atmosphere; the percentage of rain forest being destroyed, the percentage of coral reef being annihilated, top soil erosion, and various other obvious and calamitous aspects of the world's corporate enviro-homicide the risk posed by invisible financial risk is never contemplated, much less talked about as an eco-issue. Yet, the damage being done to the globe's financial atmosphere is probably the most toxic and potentially the most dangerous of all the damage corporations and banks wield as they kill off our eco-assets chasing short term profits at the expense of humanity's long term viability.
To get a grip on this thing called risk, understand that what it basically boils down to are bets made by brokers, bankers and speculators about the future direction of interest rates, oil, stocks, currencies, house prices, etc, (as part of the opportunity orgy alluded to earlier). The curious thing about these bets made over the past few years is that they never get called. Instead of paying out, the house (in this case the world's banking system, ah, here they are, the prime brokerage service providers) simply allow the players to continuously raise the stakes by borrowing more money (for a fee, the banks' incentive to keep game going); a dependency, i.e., an addiction ensues as the debt-addicted funds borrow more from their debt/crack dealing banks. Meanwhile, the pot of money at the center of the game (collateralized by Earth's natural resources) keeps going up and up.
According to the FT, this pot of money, held mostly offshore in Cayman banks, has a 'notional value' of over 85 trillion dollars. To put this in perspective, the entire output (GDP) of all the countries of the world is about 65 trillion dollars. In other words, if the game were to come crashing down, there wouldn't be enough money to pay back the lenders even if every country in the world liquidated its economy. There is simply no collateral backing up this pot of money. That's why banks refer to this amount as 'notional.' It's a notion, or concept, a theory if you like, but it's not real in any sense of that word you or I might imagine it. It's just blips on a screen. The fact is the third rock from the Sun has technically gone 'negative equity.'
As ecologists know, and economists too, imbalances and stresses in any system can only keep building up for so long before an equilibrium-inducing event (an earthquake or a stock market crash) restores balance. The geological pressures present along the abutting edges of the tectonic plates deep beneath the Indian ocean came back into balance on January 26th of 2004. Similarly, the pressure building up along the fault lines of the world's financial system is due for, as those in the City like to call it, a 'correction.'
Does it have to all end in tears, you might ask. Well, unlike those wiped out by the recent Tsunami, financial markets DO have an early warning system. It's called, interest rates. Has the system worked? No, because interest rates have been kept artificially low by the world's central bankers, principally Alan Greenspan. All that demand for more debt should, in a truly free market, drive the price of debt, i.e., interest rates up, but that hasn't happened because Greenspan has willfully manipulated the markets. The FT refers to his interest rate policies as, "freakishly low." It's true that interest rates have started to go up a bit recently, but not faster than banks (Greenspan's clients) have been able to insulate themselves to this risk by simply borrowing more, and booking more fees for themselves. Had the interest rate warning system worked, the 85 trillion in debt would have started to shrink. It hasn't it's expanding. Unbelievably, 99% of the 85 trillion in these financial bets that are not being paid off are held by just five banks, with JP Morgan Chase, (the Banda Aceh of the financial world), holding more than half the total amount. According to financial pros like Timothy Geithner, CEO of the Federal Reserve Bank of New York, that day of retribution is nigh. He calls the current environment of bad regulations, lax oversight, and huge debt dealing, "toxic."
No wonder Warren Buffet calls these bets, also known as, financial derivatives, 'weapons of mass financial destruction.' Forget North Korea and Iran, until JP Morgan stops playing debt poker with the world's assets, the biggest tidal wave killer of all time will be the Tsunami of bad paper that wipes out most of the world's economies.
The solution for this would be for Alan Greenspan and the rest of the world's central bankers to raise interest rates now to relieve this pressure, but they won't. They are, at the end of the day, bankers. Bankers know only one thing, making loans. Greenspan is supposed to manage interest rates as a benign potentate impervious to political influence, but he has showed his hand recently as willing to jump into the political fray and change the course of events with the wave of his interest rate setting magic wand.
It's no coincidence that his propensity to commit 'moral hazard' seems to grow the closer he gets to retirement. Is Alan Greenspan just another conniving, insider trading, moral bankrupt banker after all. Recent refusal to raise rates in the face of overwhelming evidence suggesting to do so implies the answer to that question is an emphatic yes.
The lesson for ecologists is to look behind the nefarious actions of environmental criminals like Exxon and Monsanto and take a look at the true demons of the biggest, most influential, and dirtiest ecology; the banks who make loans to speculators who then lean on the system in ways that, according to a coterie of respected financial journalists and traders, is forcing it to collapse. The result will almost certainly be massive world wide environmental and financial destruction on a much bigger scale than the recent Boxing day Tsunami disaster. |
