Article: US custodian banks hit by shift into cash

Excerpt: “Low interest rates have put tremendous pressure on custodian banks that manage funds for large institutions and retail brokerages, with the Federal Reserve’s commitment to near-zero rates through 2013 make it difficult to invest customer funds in safe investments that generate return.”

Article: Dismay of MF Global clients should spur change

Excerpt: “After Lehman collapsed, the UK government set up a new bankruptcy regime for brokers which was intended to ‘ensure the return of client assets as soon as practicable’. (…) Almost three months later, clients of MF Global’s London arm are still waiting for their money. (…) MF Global’s US trustee has distributed 72% of what is owed to commodities clients.”

Article: Warning on returns from MF Global UK

Excerpt: “[KPMG, MFG's administrator has warned] that customers might not get all their money back. Many clients did not realise their accounts were non-segregated until MF Global collapsed, according to Anant Shah, a fund manager at Whitepearls, a Mauritius-based family investment vehicle which claims to be trying to retrieve $35m in segregated accounts. He said the resolution in the UK was ‘disgracefully slow, given that real lives are being affected . . . it leads us as well as others to consider never opening another account with a UK broker’. Unlike counterparts around the world, such as the US and Canada, the UK has yet to return any assets to clients”

Article: KPMG defends efforts on MF Global claims

Excerpt: “The biggest issue for KPMG (…) is determining which clients have money in MF Global UK’s segregated funds. Those with non-segregated funds have been put into the unsecured creditors’ pool and (…) the issue was complicated by many customers looking to switch the status of their accounts in the final few days. (…) Under the new rules client monies are being used to pay for secured creditors.”

Book: “Lords of Finance: The Bankers Who Broke the World”

Excerpt [context: the partial collapse of the US banking system between 1931-33]: “the mounting bank failures intensified hoarding – $500 million dollars [approx. $100 bn today] in cash was pulled from banks. While most of this was stashed away in traditional hiding places – socks, desks, safes, strongboxes under the bed, deposit vaults – some found its way to very unconventional spots, including, according to congressional report, ‘holes in the ground, privies, linings of coats, horse collars, coal piles, hollow trees’. Anywhere but bank accounts.”

While some will try pushing from one side…

Article: Shake-up in US fixed income research rules (“new rules to deal with conflict of interest in fixed income research are set to be proposed by US financial industry regulators”)

Excerpt: “A recent report highlighted potential loopholes to equity rules (…). The rules did not prohibit bankers and analysts from talking outside the firm.”
→ does anyone really take it seriously that one could legislate this risk away? Sometimes an image is worth a 1,000 words, but common sense is worth 10^12 pages.

… others show for the umpteenth time that laws exist to be reinterpreted (bent? broken?) as the occasion presents itself…

Article: Basel III – the case for the defence

Excerpt: “In Europe, Paris and Berlin are again proving that they see no contradiction between railing against financiers while at the same time undermining hard-won global agreements on tighter regulation.”

… even because it is incredibly hard to comply with all the laws and regulations of all the countries (states? cities?) one operates in and still find time to actually get some work done.

Article: New rules are struggle for industry and regulators

Excerpt: “It is unclear whether a non-EU bank would have to set up a branch in the EU if it wanted to become a member of a clearing house based in the region. There is also confusion over how financial institutions operating globally would comply with Dodd-Frank, Emir, Mifid and legislation in Asia.”

In the age of multi-disciplinary events, this is one of the best. You can keep track of it live on Livestream.com, check out the event’s blog on Tumblr, its Twitter feed or Facebook page. Enjoy!

The second article in the Financial Times tries to tack the same “double standards” theme onto Germany, given its treatment of the heavily-indebted Eurozone members. It doesn’t work nearly as well, but for argument’s sake – and its use of Goethe quotes from Faust – it’s an interesting read.

Here’s the 3-minute video:

Bill Miller himself once said: “This is a brutal business, success equals survival. If you have survived, you will have succeeded”. We have said it a little differently since 1988: to finish first, you must first finish.

Mr. Miller, famous for his 15-year streak of beating the S&P 500, has announced that he will step down as co-manager of the Legg Mason Value Trust in April 2012 (he will remain at the firm as Chairman). Investors of a certain age have certainly read a lot about this fund. Is Mr. Miller’s rise and subsequent fall a matter of genius becoming overconfidence or simple probability theory playing out as per Taleb? Not knowing the inside workings of Legg Mason Capital Management, no one can really claim to know the answer. To help us think about it, we collect several links inside.

The summary: Bill Miller took the reins of the Value Trust on April 16th 1982, and in the time since then he has “produced an annual return of 11.25%, according to Lipper“. The S&P 500 in the same period returned 8.3% p.a., not including dividend reinvestment. But in the 15-year period from 1991 to 2005 the fund beat the S&P 500 every year, which made the fund’s (and Bill Miller’s) fame global. Fortune Magazine called him “the greatest money manager of our time” in November 2006.

Well, ever since then it’s been downhill and the fund is now down a compounded 9.7% per year. The list of “mistakes” is all over the web, and it included Eastman Kodak, the mother of all case studies on cultural chains that bound a company to its past. As early as 2008 the press, so happy to boost him before, was calling for his head. Just remember that it’s always hard to call if it is a research, sizing, timing mistake or simply a matter of probabilities playing out unfavorably despite a good process.

Either way, even though the company did beat the S&P 500 over 15 years starting on Jan. 1st 1991, the returns are actually slightly lower than the S&P 500 from that same date until Bill Miller’s announcement on Nov. 16th (7.4% p.a. vs. 7.7% for the S&P).

Is this a case of people/ press deifying a man and a team because they were measuring “performance” as simply “outcomes” and forgetting about “processes”? In other words, was Bill Miller an “articulate coin flipper”? Here’s the odd part: Bill Miller and his company have always been concerned about investment as a multi-disciplinary, psychologically-driven, incentives-based field. He has studied widely and fostered innovative thinking in the industry – he has even hired Michael Mauboussin to be a “chief instigator” of sorts (official title: Chief Investment Strategist). Legg Mason, Mr. Miller, Mr. Mauboussin and others have been active members (Mr. Miller was Chairman of the Board and is Chairman Emeritus) and supporters of the Sante Fe Institute, a research powerhouse focused on “complexity research expanding the boundaries of science”. That doesn’t mean their processes were above questioning, nor that they couldn’t fall prey to some of the traps of success, but there’s at least the appearance that they had it covered at Legg Mason.

Overconfidence? Here’s an excerpt from Bill Miller’s letter to Value Trust shareholders in January of 2006, only days after completing the 15th straight year beating the S&P: “I thought it might be helpful, in addition to saying how much we appreciate your confidence in allowing us to invest your savings, to say a little about the principles…” (…) “You are probably aware that the Legg Mason Value Trust has outperformed the S&P 500 index for each of the past 15 calendar years. That may be the reason you decided to purchase the fund. If so, we are flattered, but believe you are setting yourself up for disappointment.” – Sure, it could be just lip service. But for over 12 years we have been reading his shareholder letters and he seems to really be the person who gave this interview to Money Magazine in 2007.

Could it be the old problem of size trumping performance? At its peak in 2007, Value Trust ballooned up to $27 billion in assets (when Mr. Miller resigned it was down to $2.8 billion). Again, not necessarily since there is evidence of long-term market outperformance with even larger assets (e.g. Berkshire Hathaway).

Mr. Miller has been rumored to be retiring and had been complaining about two things: “The huge rise of exchange-traded funds, which allowed people to buy baskets of things which caused correlations to rise, and of course the rise in algorithmic trading.” And this Financial Times LEX article on November 18th checks that out and says yes, correlation is going steadily up. But this is also certainly not enough.

Finally, it is worth noting that Mr. Miller is another one in a list of recent departures: George Soros and Stanley Druckenmiller have also recently quit. And in a big story in August of this year, the Financial Times noted that “several of the industry’s most prominent names have had a disastrous year so far.” That list in 2011 also includes John Paulson (the best of all active money managers in the five years that ended on December 31st, 2010) and Bruce Berkowitz of Fairholme.

There are no easy lessons here, no fingers to point. Remarkable, yet just another occasion to provoke thought, rekindle humility and remember once more that to finish first, first you must finish.

China

The real risks to China’s financial system – FT.com – Two articles supposedly debate the IMF report, but it turns out their opinions aren’t that much divergent. We’ve read calls for opening up the system, and we remind the readers that when the incentive systems of enough players are aligned towards a given direction – in this case, growth, then whether it’s centralized or open doesn’t matter as much. One such example was the US housing boom and subsequent bust: oversimplifying a bit, one can argue that all players were aligned towards growth: home owners, mortgage originators/ packagers/ distributors, banks, investors, credit rating agencies etc. – and, on top of them all, the government and its agencies. The fact that the system was open, competitive and so on didn’t help much. In China, the incentives to grow are still strong and the Central government is yet to pull on the reins strongly enough. It’s not necessarily true that an open system would be better incentivized to slow down.

Europe

Banks face funding stress – WSJ.com – European banks need funding, most of it nowadays comes from the ECB due to higher perceived risk. So banks needing collateral accepted by the ECB enter strange swaps with funds and investment banks to get such “risk-free” assets at a discount to the, well, not-collateral-level assets they’re swapping with the other players. Is this spreading the risk or creating even more connections where there shouldn’t be many?

UniCredit bombshell shouldn’t be the last one – Bloomberg – UniCredit, one of Italy’s largest lenders, has recognized 10.7 billion euros in asset writedowns in its latest report. Even so it’s still trading at 0.29x book value, and that book value is propped up by “useless” assets such as deferred taxes (good luck turning a profit to use this asset) and goodwill (good luck trading goodwill for cash). Other european banks trade at P/B multiples that suggest their credibility is also way down. However, the author argues the problem could be global and that, if banks start getting as candid as UniCredit, things could get rather unpredictable.

USA

Fitch’s warning spooks investors – WSJ.com — AND — US Banks face contagion risk from European debt – Bloomberg – Credit rating agency Fitch has issued a report (for subscribers only) on the “serious risk” that US banks may face if the situation in Europe deteriorates much further. As in France being at risk, for instance. While again it’s a case of “not much new information”, the fact that they chose to go on record – even though they didn’t change the ratings of any of the US banks mentioned – has spooked investors (US banks down by 3-4% as we write, with the notable yet unsurprising exception of Wells Fargo – still down by 1%).

Why not break up Citigroup? – NYT’s Economix blog – Simon Johnson, former IMF chief economist, links to the Dallas FED president’s speech on “too big to fail” banks and agrees with him that such institutions should be broken down into smaller pieces. He suggests starting with Citigroup.

‘Aloha’ to a new fix-it job – WSJ.com – coincidentally, the WSJ.com has a profile of Michael O’Neill, the new Chairman of Citibank N.A. (not Citigroup, “just” the bank – i.e. 70% of Citigroup’s assets). Certainly an impressive profile, but we’re reminded of Warren Buffett’s axiom: “When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”

Global

Finance job losses near 200,00 as BNP, Citigroup trim employees – Bloomberg – Well, partially playing to Mr. Johnson’s wishes above, the banks are reducing their size – does involuntary reduction count?

“Culture eats strategy for breakfast”: if that was MF Global’s risk management culture, not even the world’s most powerful, accurate, on-time risk management systems – programmed and run by the world’s best minds – could save them. Because “he was from Goldman Sachs”, because of the “Goldman halo effect”, bad decisions were overlooked, too much risk was piled on, and a market shakeout took the firm down.

We wrote just days ago, regarding the “key people” aspect of an investment or company (or whatever): “Ultimately, in investments or revolutions, it’s all about the key people (…) – it’s vital to understand their real motivations, aspirations, personalities and incentive/moral systems. Not what they say it is, what it really is.” (we added emphasis for this post). Finding out about a given company’s true culture (which tends to emanate from its key people anyway, at least over time) is just as difficult and time consuming, and as we can see in this example, just as important.

The first one describes Chinese car manufacturer JAC Motors’ amazing success story in entering Brazil from scratch, using cheap yet “complete” cars appealing to a middle class perhaps in search of a first car. Yet this story is at risk because of a sudden and relatively targeted regulation change – a change that has other Asian factories formally protesting it with the WTO (World Trade Organization).

The second article describes HSBC’s sale of its large consumer financing operation in Brazil, Losango. While the main motivation for the sale is certainly a CEO-led restructuring that has HSBC shedding assets and laying off tens of thousands globally, it doesn’t hurt that delinquencies are on the rise.

This NYT story highlights that some financial instruments are too untested to trust completely. Apparently there’s enough leeway built into the CDS contract for this “voluntary” deal (to take a 50% haircut on Greek debt) NOT to be considered a default on the terms of the CDS, meaning people who bought “insurance” get nothing. Another thing that captures our attention is that there’s a committee that decides whether or not this is an event of default – and it would seem like a one-sided committee in favor of CDS investors. However, the big banks’ incentives are more aligned towards making the agreed debt deal come through – to save 50% and perhaps avoid a larger meltdown. Not surprisingly, this committee has already indicated that this “voluntary” swap does not constitute default…

And this Bloomberg story addresses the counterpart risk issue: in this immensely interconnected financial system, it just may be that too much risk-spreading actually increases the chances of “contagion” or “viral spread” of troubles. If that happens with a over-the-counter, not-centrally-cleared instrument such as the CDS, there could be big consequences.