Lawmakers Skewed Priorities in Proprietary Trading
By Jeremy Weltmer • Thursday, July 8, 2010 3:45 pm
As part of the Frank-Dodd bill for financial “reform,” financial institutions that benefit from government protections like federal insurance of deposits will be restricted from investing any more than 3% of the bank’s capital for the profit of the bank. As menacing as this may sound, it ignores two significant loopholes that lawmakers left in the bill.
Perhaps unintentionally when the bill was ramrodded through a partisan conference committee in the dead of night, lawmakers left a significant amount of ambiguity on the regulation surrounding the making of markets. Because large banks fill the crucial role of making markets and buying securities ahead of when customers demand them, markets and securities can remain very liquid. Likewise, banks can make a profit on making markets if the security purchased rises in value between when the market is made and when the consumer purchases the product.
In line with this, companies have been shifting traders from proprietary trading desks to making markets for other divisions. One of these traders might trade a security for which he expects there to be demand in a week or a month and then unload that security if he no longer expects a demand for it, pocketing the difference for the firm. There is no easy way to curb this practice without harming market-making, which remains essential for financial markets to function, yet it either castrates the bill’s provisions relating to proprietary trading, or it leaves all the power in the hands of unaccountable regulators.
The second major loophole, which the Wall Street Journal characterizes as big enough to “drive a trader's ego through,” does not prevent the proprietary trading of all securities, but it in fact allows for speculation on over 60% of the US bond market. Specifically, companies remain able to trade Treasurys, bonds issued by government-backed entities like Fannie Mae and Freddie Mac, as well as municipal bonds however they see fit, leaving them speculative access to a $20 trillion market.
Lawmakers left this exemption first and foremost because of the flawed perception of US debt as safe from losses, a view belied by the impending US credit downgrade. Moreover, anyone with access to news media could testify to the riskiness of Fannie and Freddie, and financial news sources continue to warn about the overvaluation of the municipal bond sector. Nefariously, politicians left this exemption to allow the private sector to sop up as much government debt as possible as they do not foresee a time when the US will not spend more than it collects.
Yet when these banks leverage these positions, perhaps expecting US bonds to drop in value, the positions could become extremely risky or have very unfortunate effects on the US ability to borrow. While banks may not engage in these practices, the exemption simply shows politicians’ skewed priorities.
While the bill does allow for regulators to stop any high-risk trading that affects the soundness of the institution, one is then left with a conflict of interest in which the US government is telling banks how much US debt they can safely hold.
A Unified GOP Congress Benefits Both Shareholders and Workers
By Jeremy Weltmer • Wednesday, July 7, 2010 3:07 pm
ASA has discovered a notable correlation between which party controls Congress and the changes in both shareholder wealth over time and unemployment in each year. While correlation does not necessarily imply causation, the continuing and strong historical correlation between the two remains highly incriminating. Take a look at the results:
Treasury Misunderstands Credit-Default Swaps and Taxpayers Foot the Bill
By Jeremy Weltmer • Tuesday, July 6, 2010 12:05 pm
In the dark days of 2007 and 2008 when investment banks began closing their doors, the financial products division of the insurance giant AIG began to receive collateral calls on their credit-default swap contracts to the tune of tens of billions of dollars. This is the point at which the government stepped in to settle the situation and prevent a collapse of the system by closing out the complex insurance-like contracts, or so the official story goes.
Gary Gensler, Chairman of the Commodity Futures Trading Association, disagreed with that analysis in nuanced, but significant ways in testimony before the Financial Crisis Inquiry Commission. Most importantly, the inherent danger of both AIG and credit-default swaps were vastly misrepresented. Much of this stems from a general misunderstanding of what precisely a CDS does. Basically, it allows the seller to issue it based on an underlying asset and insure that it will not default. The defining differences between a CDS and an insurance contract have to do with the possession of the underlying asset; normally, to insure an asset, one must own the underlying and collateral must be posted at the front end of the deal.
So, to demonstrate the differences between the two scenarios, one can trace each kind of deal. If Goldman Sachs owns a set of residential mortgages and wants to hedge its risk on those mortgages...
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Obama Embraces Euro-Socialism as New Europe Rejects It
By Jeremy Weltmer • Thursday, July 1, 2010 4:17 pm
Over the weekend in Toronto, Obama dug his hole even deeper. As the Wall Street Journal reports, by the end of the conference, “the wealthiest of the Group of 20 countries said they would halve their government deficits by the year 2013 and ‘stabilize’ their debt loads by 2016, a signal to international markets and domestic political audiences they are taking seriously the need to wean themselves from stimulus spending.”
Now, this seems superficially like a significant positive for U.S. taxpayers and the young adults who will inherit the fiscal excesses of the administration, especially given that “a White House statement said that government debt in the fiscal year ending Sept. 30, 2015, would be at an ‘acceptable level.’” Yet several questions stem from his analysis of the U.S. fiscal future. First and foremost, one must ask how he is budgeting, given that his party has decided not to fulfill its Constitutional duty of proposing a budget, and the budget proposed by the Republican Study Committee does not balance the budget before 2020, and the $20 trillion in publicly-held debt would then clock in at a similar percentage of GDP as Greece’s. Moreover, while he asserts that the debt in 2015 would be at an “acceptable level,” 2015 is the year in which Moody’s expects that the US will lose its AAA credit rating.
To explain the inexplicable, “President Obama said that next year he would present ‘very difficult choices’ to the country in an effort to meet deficit goals.” Moreover, “the President cited...
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The Dénouement of the Dollar
By Jeremy Weltmer • Friday, June 25, 2010 11:23 am
Perhaps under pressure from US leaders like Sen. Chuck Schumer, perhaps under market pressure, the Chinese central government has decided to take the yuan off a dollar pegging and peg it instead to a more flexible basket of international currencies, as it had been before 2008. Now, initially, this will hurt US consumers by making imports from abroad more expensive in US dollars when purchased from China, and it will likewise hurt US retailer and some manufacturing firms.
In the longer run though, it also allows US companies invoicing in US dollars better access to untapped Chinese markets by making US goods comparatively cheaper and increasing the purchasing power of Chinese consumers. The Wall Street Journal reported that, in the long-term, this will likely...
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Democrats Aim at BP and Instead Hit Retirees
By Jeremy Weltmer • Friday, June 11, 2010 11:46 am
In recent weeks, fiscally ignorant Senators and Congressmen have been trying to put the thumbscrews to BP and nix its dividend until some indeterminate point in the future. Congressman Welch and 40 of his colleagues wrote in a letter to BP,
“as BP presides over one of the greatest environmental and economic catastrophes of our time, we find it troubling that your company plans to divert financial resources to shareholder dividends and slick marketing campaigns….We urge you to halt your planned dividend payout and cancel your advertising campaign until you have done the hard work of capping the well, cleaning up the Gulf Coast and making whole those whose very livelihoods are threatened by this catastrophe. Not a moment before then should you return to business as usual.”
Senators Schumer and Wyden wrote that they
“find it unfathomable that BP would pay out a dividend to shareholders before the total cost of BP’s oil spill clean-up is estimated. The total cost of the clean-up estimates could reach $37 billion if the well leaks until relief drilling is completed in August, according to Credit Suisse Group AG. While we understand the need to reassure shareholders that the disaster in the Gulf will not substantially impact BP’s long term financial health, we are concerned that such action to move money off of the company’s books and into investors pockets will make it much more difficult to repay the U.S. government and American communities that are working around the clock to stem the damage caused by this devastating oil spill. We urge you to reconsider your dividend pledge until accurate costs of clean-up and liability claims can be estimated. We are certainly not opposed to BP paying dividends after the well is capped, clean-up has been completed, and the victims have been justly compensated.”
Perhaps even more worryingly, the Wall Street Journal reported that “a Justice Department official told Dow Jones Newswires on condition of anonymity Thursday that the agency has no plans to seek an injunction that would block BP from paying dividends, but hasn't ruled out that option at some future time.” As high-minded as this rhetoric may sound, it both belies the facts of BP’s finances and ignores the ramifications of not paying a dividend.
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When the Markets Get It Wrong: US Government Debt
By Jeremy Weltmer • Wednesday, June 9, 2010 12:26 pm
When the media claim that credit default swaps are a terrifying instrument, they are completely correct, but for the wrong reason. Whereas the talking heads would have Americans fear the instruments, what the instruments tell us remains far more terrifying. Basically, a credit default swap offers a way to insure a debt (whether it be a corporate bond, a mortgage, or a government note) so that if the borrower cannot repay the loan, the creditor has limited his risk. They function as a sort of contract; the buyer pays upfront for the insurance against the risk, and if the debtor does default, the lender calls in the policy and only loses what he paid for the contract.
So, credit default swap pricing shows the raw pulse of the market: one can quantify the cost of risk on any government bond. So, today, insuring $10 million of US government debt for 5 years costs about $43,000 whereas insuring $10 million of Greek debt for the same time period costs about $730,000. CDS pricing shows clearly that the market values Greek government debt at about 17 times as risky as US debt, which sounds encouraging to Americans.
But, as 2008 showcases, sometimes the market can underestimate risk. Of the major world economies presently embroiled in a debt crisis...
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Why Government-Enforced Financial Security Destabilizes Banks
By Jeremy Weltmer • Friday, June 4, 2010 4:21 pm
Thanks to the recent swathe of banking regulation, investors can expect the money market funds associated with their brokerage accounts to become less and less temping as cash management products, with disastrous consequences for the system as a result. At the moment, these funds serve as a place to park uninvested funds while looking for an appropriate opportunity or as a longer-term location to store cash as a risk hedge in a larger portfolio plan. Most brokerage clients might not even consider it an investment; thanks to automatic sweeps of cash in accounts, clients can earn interest on their uninvested balances.
As anybody with such an account can attest, the returns have tanked in the past decade, and thanks to investors’ friends at the SEC, they stand only to drop...
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The SEC: Defending the Indefensible
By Jeremy Weltmer • Tuesday, June 1, 2010 5:13 pm
In the past several weeks, the SEC has attempted to single out certain key firms on Wall Street like Lehman Brothers, Bear Stearns, and others that took recovery funds as having engaged in deceitful accounting with a practice known as a “Repo 105 transaction.” When testifying before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, SEC Chief Accountant James Kroeker testified that, “based on the requests [made to 19 key banks about repo transactions], no information has come to our attention that would lead the staff to conclude that inappropriate practices were widespread.”
But, the Wall Street Journal reported that the vilified practice was really just standard form on the Street....
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