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.”

However, on risk management issues, we tend to defer to Taleb (new talk posted inside – H/T Farnam St. Blog). Also inside are links to other recent posts on risk management culture.

The Taleb video:

Great bit from the video above: “People have this problem with risk management: they think it’s two separable items. You have this growth, and then you have the risk. They don’t understand that first, to get rich, you have to survive. People don’t understand this logical precedence of one over the other.”

Other recent Buysiders.com posts on Risk:

Risk management culture – Jan. 4th, 2012

“He was from Goldman Sachs” – Nov. 3rd, 2011

The excerpts put together below make Bob Kaplan’s speech music to our ears:

“The big deliverable coming from this risk management program is how important organizational culture and leadership are. (…) the first group of participants were surprised on how much time we spent more on culture and leadership issues than we did on technical issues. (…) the big difference between the successful and unsuccessful companies along this dimension is not that the successful ones had dramatically superior technical competence, (…) they recognized the importance of embedding the risk management function in the way they thought about their strategy, reviewed their strategy (…)”

Here’s the video (2:30):

Remember: “Culture eats Strategy for breakfast”.

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?

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.

Here’s the embedded video:

On the first question, we’ve posted on this in Feb. 2010: It’s well know that there is an ever-present and history-defying trend to extrapolate the current situation into the future (and future in this case means 2-5 years ahead). To ignore cycles having so much historical data available is amazing. If everyone believes the market will remain this volatile forever, that’s precisely when it starts to soften up.

But there’s another flaw, and that is one in which “visibility” is confused with “low volatility”. Investors believe that “visibility” is “good” when things are calm and that it’s somehow “cloudy” when volatility rises. It’s like saying the 2004-2007 period was “high visibility” and yet the year ended as it did, and 2008 was what it was. In that same theory, a “high visibility” period began anew sometime during 2009… When one looks at Brazil in 2009 with its spectacular rise from the crisis’ lows, the market had to have been riskier after the rise than before it, yet some saw the precisely inverse relationship. Those who were cautious built the “cash as strategic weapon/ both cushion and cannon” stake and were ready to take advantage when things got more agitated.

The second question is obviously more complicated and we’ll just propose the “conversation starters”:

First and foremost, we’d point that volatility shouldn’t be a measure of risk at all. Risk, as we define it, comes from “not knowing what you’re doing” in the many dimensions of investment analysis, be it idea sourcing, networking, research and ultimate execution – what instrument(s), what sizing, what hedges and why etc. It also comes from paying prices that don’t allow for significant margin of safety. Of course, it also comes from not allowing time for the idea to play out – if you need the money back in a month and anything goes modestly south, it will turn from an opportunity to increase your stake into a realized loss. By the way, this last factor is also influenced by the type of customers one “chooses” – those with a happy trigger and weak stomach can cause havoc on a great portfolio that fell just a little bit. Finally, it can also come from leverage. But if one approaches the processes with the required seriousness (and skills, hopefully), increased volatility shouldn’t a problem. See the note about “cushion and cannon” above.

Another point: as we’ve argued before (here and more recently here), in the case of the ages-old search for the “risk-free rate” to power valuation models and calculations, there is always the choice of not making volatility such a relevant factor in your portfolio management approach. It’s useful as a mental model and habit not to worry about short-term volatility. As Buffett has proposed many times, you should be looking for the investment opportunities that you would feel comfortable owning even if the markets closed for 2, 5, 10 years.

Finally, when volatility strikes, don’t panic.