RWCG


More Stupid Than I Could Have Possibly Imagined
May 31, 2012, 8:22 pm
Filed under: Uncategorized

As dismissive and snide as I’ve been regarding the hand-wringing over JP Morgan’s $2 billion loss, this (which I just saw, just now) is a real story.

If true, it sounds like they had been marking their (tranche? I have to assume) trades at different levels than those set by the dealer desk. And, no internal checks or anything else forced any sort of provision or price adjustment. That? Is mind-boggling.

Jumping ahead, what it presumably means is that they were valuing and marking index tranches purely to a model, unadjusted. At least, I can think of no other explanation. The best I can imagine on their behalf (that is, if I assume the explanation involving minimal stupidity on their part) is that in their ongoing trading they were consciously trying (and perhaps succeeding, for all I know) to take advantage of tranche skews vs. the index, and came up with a way of marking accordingly (i.e. for which sum of tranches would always = index). This is a known issue with these instruments, but to actually skew marks accordingly on open positions just strikes me as dumb. They would have been only fooling themselves: when the time comes to get out of the trade, the market doesn’t care about your ‘model’.

But this would explain, perhaps, the longtime mystery of why they always seemed to see so much value in this or that tranche that they thought it made sense to push the market around: the market was ‘wrong’, they felt, because their model said so! So they just kept on buying. Oh brother.

Somewhere in some comments section, I forget where, someone brought up the possibility to me that this was a model issue. I dismissed the idea as obviously ridiculous on grounds that all the instruments in question have visible, quoted prices and no one here and now, in 2012, would have been so stupid as to actually mark index tranches purely to a model for their books & records (and not adjust valuations back to market, i.e. to the dealer marks). It appears that I may have to eat my hat on this one: if the above article is any indication, JP Morgan’s CIO was indeed that stupid.



Reminder: Technically, Too Big To Fail Is Not Actually A Thing
May 31, 2012, 6:02 pm
Filed under: Uncategorized

Despite its almost comically hypermelodramatic title, there’s little to argue with in Simon Johnson’s post Jamie Dimon And The Fall Of Nations at Baseline Scenario. Little, that is, if you let this slide:

This bank [JP Morgan] is “too big to fail” – meaning that if it were to get into difficulties, substantial financial support would be provided by the Federal Reserve System (and perhaps other parts of government) to prevent it from collapsing.

This is stated so matter-of-factly it’s possible to gloss over it as you’re reading without quite stopping to ask…well, I mean…Huh?

Here’s the thing. I looked in my pocket copy of the U.S. Constitution for the section on “too big to fail”. Didn’t find it. Curious, I went over to the Stanford campus and borrowed Finance Professor Anat Admati’s textbook on introduction to banking. Turning to the index, I looked for Too big to fail and Fail, Too big to. Not there. The plot thickened.

When did we all agree that “too big to fail” was an objective thing that we weren’t going to argue with any longer? I’m still here. I’m still arguing.

JP Morgan is a company. There is a thing that can happen to companies when they can’t pay their bills for whatever reason, which is that they can declare bankruptcy. I am sorry, but that is the established process. If you are arguing for some other process, there is no legal basis for it, so you’re the one with the burden of proof, not me. Fuck this too big to fail bullshit already. I’ll see your too big to fail and raise you one chapter 11.

In fact this is something both left and right should (supposedly) agree on right? We’re all mad about the bailouts aren’t we? Isn’t the consequence of being mad about bailouts supposed to be, fuck bailouts? How did things get so convoluted that when everyone got mad about bailouts we proceeded directly to assuming bailouts were business as usual unchangeable facts of life?

And the thing is, if you take away this “too big to fail” nonsense, the rest of Simon Johnson’s article basically becomes moot. Try it at home. No too big to fail, no perverse asymmetric banker incentives to lead to Our Nation’s Fall. Done. Problem solved.

Now I know what you’re going to say, you’re going to say that I’m being dumb/naive because ‘realistically’, under the current political-economy context we have in place, Congress is very very very likely to treat certain banks as “too big to fail”, JP Morgan among them. Fair enough. So, we can both agree we have a problem on our hands, which is, and let me try to state the problem fully not partially, When (a) [certain stuff e.g. a bank blowup] happens, (b) Congress will [bailout/other stuff that treats a bank as "too big to fail"], (c) costing us money and probably also leading to the ill effects/incentives Simon Johnson talks about.

But let’s not forget that solutions to this problem (and avoiding (c)) can involve addressing/preventing (a), as most of conventional wisdom seems to be trying to do (futilely, IMHO), or they can involve addressing (b). All I am saying here is, give (b) a chance. It’s not like anyone’s making me super confident they have a good solution to (a) after all.



Does Talking About A Problem Cause The Problem? and other stupid questions
May 31, 2012, 9:50 am
Filed under: Uncategorized

Since it’s apparently react-to-things-I-flagged-yesterday day here at RWCG, I felt like I should say something about that paper on whether ‘the debt ceiling debate hurt the economy’. The problem is I can’t figure out how to respond since no matter how many times I read it and spin it around in my head, I parse it as a nonsense question, something that is simply ill-constructed.

To my way of thinking a ‘debt-ceiling debate’ simply can’t, logically, ‘hurt the economy’. The economy could have been ‘hurt’, or gotten markedly worse, around the time the debate occurred, obviously, and I gather this is what the authors marshal evidence to ‘prove’, but that’s a nonsense way of looking at it. If the economy was ‘hurt’, which okay is possible, it’s not because of the ‘debate’ or the ‘standoff’, it’s because of the underlying factors that led to that debate/standoff (which at most ‘released’, or laid bare, those factors). To say otherwise is like saying medicine (however ineffective) caused the disease. So I tend to dismiss this idea as yet another economist-foisted, statistics-heavy ‘analysis’ that is automatically wrong based on the methodology.

But if you want to read a more thorough and measured response, try PostLibertarian.



Wake Me When The Market Becomes ‘Fair’
May 31, 2012, 9:03 am
Filed under: Uncategorized

Deus Ex Macchiato says it is fundamentally corrupt for investment bankers to give discounts/better execution to preferred clients. While on a theoretical level that sounds right – and while I’m sure there are plenty of regulations and training courses and ethics pledges and such, even ones that (for all I know) specially apply to investment banking, to back it up – when people say things like this I wonder why they single out finance for their scorn here.

Insiders and preferred clients getting better deals just doesn’t strike me as something magically thought up and invented by investment bankers. To me, it seems like the way of the world.

You can get better prices on yogurt by using a supermarket’s ‘club card’. You can get better prices on clothes buy buying them during a ‘sale’. You can get a better deal on your cable (or telephone, or car insurance, or…) by calling them up, acting like a parsimonious dick, and threatening to switch. You can get free hotel rooms in Las Vegas by gambling a lot. Businesses get better deals on health insurance for their employees by ‘negotiating’ to buy that insurance in bulk (indeed, everyone seems to approve of this). People with good bargaining skills can get better deals on cars. Or houses. Which reminds me, I assume people who know good brokers have the inside scoop on houses coming to market, what the likely clearing price will be, etc. as against people who don’t. And so on.

This isn’t meant to be an exhaustive list, and obviously these aren’t all instantiations of exactly the same phenomenon, but all I’m trying to illustrate is that these concepts of ‘best execution’ and ‘fair access’ that are, supposedly, ‘the foundation of a fair market’, don’t actually seem to exist anywhere that I can see. I would kinda like it if they did! Maybe there could be one giant centralized website that openly posts best-execution prices for all goods and services in the economy. But till that day comes I’m not sure I understand the reason to specially criticize them for not existing in one particular area of the economy e.g. new stock issuance arranged by investment bankers.



The Principles-Based Community
May 31, 2012, 8:47 am
Filed under: Uncategorized

Okay, I’ve officially lost the narrative regarding what ‘principes-based regulation’, or Pabst Blue Ribbon for short, is even supposed to be. Arnold Kling:

My claim is that with principles-based regulation, you could be asking this question [“How were they [JP Morgan's CIO team] compensated on an annual basis? Were they paid a salary and a bonus, and was the bonus a function of the profitability of the group, or was the bonus a function of the hedging ability of the group?”] ahead of time during an onsite audit.

I suppose it’s true that with PBR, the government could ask JP Morgan this question. But! I also suppose it’s true that the government could ask JP Morgan this question without PBR. Kling is quoting someone named Andrew Lo, who says flat out: “I know that certainly the government can get that answer with a single phone call.” Does Kling think Lo is wrong, and that we need “PBR” first? Is that his point?

I really can’t envision what PBR has to do with anything here. It seems neither necessary nor sufficient.

The Volcker Rule for example makes some statements about how people are to be paid. Their pay can’t reward risk-taking, or something along those lines. That’s part of the Volcker Rule. Thus, under the Volcker Rule, presumably regulators could and will enforce the compensation part by e.g. asking banks how their employees’ pay is calculated. (Again, I totally assume they already can and do this though). Anyway, is that PBR? Not PBR? If it’s PBR then the Klings of the world should rejoice, as Congress is clearly already passing PBRs up the wazoo. If it’s not PBR, then who needs “PBR”?

The more this PBR thing is elaborated, the more of a red herring I think it is. At least, under the loving stewardship of Arnold Kling’s nascent PR campaign it appears to be quickly morphing into a catch-all for ‘reformist regulations [he] would like’.

To the issue of compensation itself, in a technical sense I’m not sure people focusing on ‘how compensation is calculated’, and wanting it not to be tied to profits, are really thinking things through (or even being consistent). Say you work for a bank. How big is your bonus? Well clearly (unless you have some kind of guarantee or multi-year locked-in bonuses?) if there’s no bonus pool, you get no bonus. How can there be a bonus pool? If the bank makes profits. Does a bank’s profits depend in a nonzero way on the profits of [insert group here]? Sure does! Money is fungible! Profits are fungible!

What this establishes is that, no matter who you are or which group you work for in a bank, your bonus depends in a nonzero way on the profits of your group. In other words, the first derivative of [your bonus] with respect to [the profits your group makes] is automatically nonzero. It might be tiny, but it’s not zero. There’s no way around this. Hence going around hand-wringing over whether this or that group is getting paid based on some formula that depends, at least in part, on their profits is wrongheaded. I’ll answer that for you right now: Of course it is.

Moreover, in other conversations anyway, that’s the way reformers say they want it. Look at the big push to pay people more in stock (or even clever structured products), and have clawbacks. What is that, I ask? If you get paid in stock, and/or your pay can be clawed back, then your pay depends on the bank’s profits. Which (again) depends in part on your group’s profits. If only because of that whole money being fungible thing. So – due in no small part to the tireless bleating of reformers – bank employees are already very long their own employer. It follows that if that employer makes big phat profits, those employees stand to gain, personally. Again this is all fully by intent and design because (before they glommed onto PBR a couple weeks ago) the well-meaning reformers of the world were all agonizing that bank employees were too short-sighted, didn’t have enough skin in the game, didn’t have the right incentives to make sure their bank didn’t blow up, and so on. Well, congratulations reformers, you’ve gotten your wish: bank employees’ personal fortunes are highly intertwined with their banks’ profitability (even more so than any regular employee is long his employer). Just like you wanted!

Except now you suddenly don’t want it.

So, to summarize: Bankers’ pay should be inextricably tied to the profitability of their bank – except, also, it shouldn’t. Do I have that right?

Two words come to mind here: PRINCIPLES. BASED.



I Can’t Wait To Give My First TED Talk
May 30, 2012, 5:05 pm
Filed under: Uncategorized

I wonder what I’ll say in it. Probably something cool.

To be prepared, I practiced saying awesome stuff that people clap in response to, in front of a mirror for 1.5 hours this mid-afternoon. It went pretty well. Preparation is key I think.

It’s gonna be awesome.

UPDATE 6/2: Ok, now I’ve shaved my head and bought a turtleneck. I am so ready it’s not even funny.



Vindication For Dixon-Neely
May 30, 2012, 8:10 am
Filed under: Uncategorized

Presumably because I’m a terrible blogger, I haven’t commented on the weird blogosphere events surrounding some weird, left-wing loser** ex-con whose name would come up in a Google alert if I wrote it out. All I wanted to observe here is that it appears that North Carolina teacher Tonya Dixon-Neely was only partially wrong.

No, you can’t be arrested for criticizing the President. But you can be arrested for criticizing weird, left-wing loser ex-cons.

**the fact that this person is a loser is merely my personal opinion, unsupported by objective fact




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