Monday, September 19, 2011

Because they Aarrgh

The Pirate Party in Germany got 9% of the vote in the Berlin elections.

- Why are they called the Pirate Party?.......

- Because they "Aarrgh!".

TMM never thought they'd get the chance to use one of their favourite jokes topically though in this case "because they'll force the Greeks to walk the plank" may be as apt an answer.

Now other brewing things.

First, Adoboli and UBS's now $2.3bn rogue trading loss. The latest news on this front is that Adoboli traded equity index futures and "hedged" these positions with forward-starting ETF trades, in a manner remarkably similar to Jerome Kerviel. However, UBS, unlike Societe Generale, did not pick up the fact that in some cases, the false trades did not appear to have counterparties (Kerviel, in such cases, allegedly said they were mistakes and then booked a different trade). The FT reported over the weekend that these trades dated back to October 2008. TMM are astounded that Adoboli was able to run such a record of false trading in such a similar manner, despite the events of January 2008. UBS's risk controls are clearly even worse than TMM thought on Friday.

TMM noted the similarities between Leeson, Kerviel and Adoboli's starting in the Back Office and then moving to the trading floor, and thus their expertise in the risk management and settlement systems allowed them cover their tracks for long periods of time. But the similarities don't just end there. It is generally very difficult to hide trades that require settlement in the next couple of days, or exchange margining, especially in the aftermath of Leeson's famous 88888 "error" account. However, Leeson's losses were not all in the error account. There was also a fictitious trade for 7.78bn Yen, where Leeson "sold" some options to generate the appearance of cash in an account, but this was an OTC trade. Kerviel also worked on the Delta One desk, trading equity swaps, ETFs and so forth, with OTC hedges against equity indices. And now, Adoboli is alleged to have done the same.

TMM reckon that there is now sufficient evidence that the risk controls with relation to OTC trades is woefully lacking, partially because of the underinvestment in systems over the past 20years (that TMM witnessed firsthand at several of the banks they have worked at in the past). Often ill-fitting trade templates have made booking non-standard trades into systems difficult and in some cases impossible (TMM remember a trade being booked in Microsoft Outlook at one of their previous employers), but this is a different issue entirely, as the Adoboli trades were pretty vanilla. What astounds TMM is that the back office did not pick up the fact that these trades would not have been confirmed with the alleged counterparties. Clearly, by the time these have been picked up, both in the SocGen case and the UBS case, it was too late and weeks/months after the trades had been booked.

But it's not just the actual confirmation with counterparties that can be the problem here. In the absence of clearly marked exchange prices, OTC trades are usually valued using internal models taking market inputs from broker pages etc. One of the more bizarre instances of rogue trading TMM have heard of was an internal trade between an options market maker and another trader on a different desk. After a few weeks of both traders posting a profit on said trade (marking against their own curves/surfaces), the middle office was eventually alerted but it turned out there was a lot more exposure from the guy mismarking the book with the rest of the Street. Of course, the problem here was having adequate internal marks, but the products themselves were not particularly sophisticated. TMM struggle with the need for these products to be OTC in the first place (given their simplicity makes them easily Exchange-mutable), other than to add margins to the banking cartel, but given that they have been involved in several rogue-trading losses now, it seems obvious to us that regulators need to apply more pressure upon banks to move these products on-exchange. That way, under-resourced back offices would be able to concentrate on the exotic trades, thus reducing the risk of rogue trading more broadly. As John Hempton says, there will always be criminals, but you can minimise the risk of such actions generating large losses and, to TMM, migrating vanilla derivatives on-exchange seems like a pretty sensible solution here.

And now, onto Europe. Schaueble & Weidmann's comments with respect to leveraging the EFSF have sparked rumours that Timmy G has lost his job running Europe for being too direct and suggesting the obvious. Very Un-European. Geithner last spotted trying desperately hard to steer the Eurostriches in the direction of the finishing line.

The usual imminent Greek default rumours have been spreading this morning, with tomorrow's EUR 769m coupon payment a point of focus, but TMM reckon it is a bit more subtle than that. Evidently, the Troika are becoming less enamoured with the Bubbles, and the view that Greece has to be cut loose is gaining more traction in policy circles. The problem, as Merkel stated last week, is that there is no current way to shield everyone else from the consequences. Much like demolition engineers trying to figure out where to stash the charges in order to avoid the building falling on top of those around it. TMM find it encouraging that the Eurocrats at least understand this (unlike the Paulson Treasury's belief that the fall-out from the Lehman default would not be large). That means that while the sabre rattling appears confrontational, like the Greeks being asked to walk the plank, that there is a good deal of double-bluffing going on here. We would need to see the rest of the PIGS backstopped to a degree that markets would not immediately attack Italy, Eurozone banks recapitalised to the extent that they could cover the theoretical losses of Italy defaulting, and capital controls imposed to prevent domestic bank runs.

The Greeks, for their part, have realised they have lost the upper hand that they had as recently as July. Still running a primary deficit of something like 3% (see chart below), the domestic consequences of a unilateral default in terms of a "sudden stop" would be significant. And TMM find it interesting that Venizelos spent time talking about the need for a primary surplus to shield the country, as well as reiterating Greece's need to reform and consolidate, as well as the cabinet meetings aimed at producing more fiscal measures in order to meet the deficit targets necessary to receive the next loan tranche. TMM reckon (though this could be their famous last words!) that the Greeks are unable to take the drastic unilateral default step without running a primary surplus, which TMM reckon should happen sometime next year.

Of course, not running a primary surplus is not a complete barrier to unilateral default. As many have pointed out, governments can only continue austerity as long as the population will allow it. With no elections until 2013, there is some political cover, and while there have been riots and protests, these have not been to the degree that they threaten implementation. Such moments come when riots become "serious" rioting, i.e. - a lot of people die or the armed forces get involved. Think Arab Spring. We are not there yet, but there is certainly plenty of potential for the situation to develop to that point.

But for now, TMM are sitting on their long US equities, but are worried about the actions the Eurostriches may have on their DAX position. Meanwhile, we note Asian Air Traffic Control has given landing permission to a large Pink Flamingo.


Anonymous said...

well, there really is no way in which a computer can tell whether an OTC trade is bogus or not, so the blame must lay with their risk managers for sure

Leftback said...

That's not a Eurostrich, it's an EMU......

Anonymous said...


Dave Rosenberg says forget Operation Twist. Bernanke will shock everyone with what is about to come. See his Friday's "Breakfast with Dave" letter. Mauldin and Hero Hedge picked it up. What are your thoughts? Thanks.

Leftback said...

Anyone have any idea who SOLD the CDS on Greece? We can speculate on who the buyers were, but if Greece goes the way of Argentina, the originators of those swaps are going to be the AIG at this party, and require bailout/nationalization. Also, how big would such losses be? These would need to be added in to the haircuts taken by the bondholders in guesstimates of the amount of TARPage/EFSF* required.

* European Financial Stabilization Fudge

Leftback said...

Operation Twist is surely priced into the Treasury market, since it has been effectively front-run by the primary dealers. The effect of its announcement is likely to be profit-taking, and a move towards risky assets, 2010 style, no?

Secret--Sauce said...

Rumor has always been that Greek banks are big CDS sellers - for them it makes sense, for if Greece defaults they're toast, but if not they pocket the premium. (However, anyone buying Greek CDS from Greek banks needs to have their head examined - talk about wrong way risk!)

But this may be moot. I've said it before, but you might want to read that ISDA master agreement. The definition of "default" is not as clear cut as the OED would have you believe.

It ain't for nothin' that securities law is a lucrative profession!

Leftback said...

Right, the Greek banks are the logical CDS sellers. Like AIG they would assume that it will never happen or if it did they would be bailed out, and besides they profited at the origination, so it was a classic IBGYBG trade.

Speaking of rogue trades, where's Cassano, and why isn't he helping with inquiries like the UBS guy? Perhaps he has relatives? You know, family. So the Manhattan DA had to fuhgeddaboudit.

We read the Rosie piece, Anon, and it is not one of his best - rambling and all over the place, Rosie is brilliant but his timing is awful - his problem is always being too far ahead of the game. Unless Greece actually defaults tomorrow, this is Bernanke's meeting to use a powerful weapon. He will DO NOTHING, thus perversely instilling confidence. Operation Twist is already done, the European banks did it for him by buying USTs in a FTQ.

BB will save his powder until he deems it most advantageous to deploy it. I believe his major concern is to defuse a 2008-style Eurodollar squeeze by whatever means available, but he is unlikely to throw napalm until the dollar shows excessive strength that can trigger a disorderly unwinding.

Skippy said...

LB, I agree that OT is priced, but could "active" OT have an impact? Some have suggested that an active OT program might involve 2-3 times more buying of the 7-10 and 30-year part of the curve compared to QE2. That might cause a pavlovian buying of equities (good for a trade). However, I doubt it will succeed in reviving private sector demand for credit.

Secret--Sauce said...

I think in the beginning some of the sellers were just setting up cheap synthetic long debt positions, but they've probably long since left the building.

As for the Artful Dodger's possible manipulation of the yield curve, even if realized, well, 15 bp even at the long end of the curve just doesn't give us wood.

Amazing how no one talks about the losses that would be inflicted on tax payers when such longs are unwound in a higher interest rate environment. Last I checked, a 300 bp move in 20-year paper kind of ouches.

Anonymous said...

Here's the Rosie comment referred to by Anon@2:38:-

Leftback said...

Hard to see how 15bps lower than where we are would do anything at all. As I said, it's all been done.... if they announce it we would get a knee-jerk risk-on move.

As for the costs of a 300 bp unwind in a "higher interest rate environment", I refer the honorable gentlemen to the answer that I gave previously, in regard to the Japanese experience. We will not see a 5% 10y this decade, so you can find some decent yield and sit in it. Selected junk bonds and dividends can hardly find a better environment than 2-3% 10y and 0-3% inflation. Welcome to what really is THE Normal, the 5% growth in US GDP was freakish and artificially generated by pumping housing and credit.

Anonymous said...

LB, appreciate your thoughts on BB.

Anonymous said...

C says'
call me 'confused' ,but what would be the point of buying the long end further than it has been bought already just by letitng fear move the market. IF the Fed stays out and the Eurocretins continue as they are then govt debt in the US and Germany etc is going to be priced down anyway so why use any amuntion doing something the market will do for nothing?
Moreover there is no reason why this cannot continue as there is very little postive economic data to cause risk buyers to rush in here and the political risk imo more than outweighs any yield chasing pluses.
I would have thought whatever the Fed does should be aimed at flushing out safe haven moneyflow back into circulation and n that basis not doing what people have expected and priced for looks a better bet.

Skippy said...

C, the only value I could see in the Fed implementing an even more dovish policy is to reverse some of the dollar strength. In the Dudley/Squid view of the world, 'financial conditions'have tightened because the dollar has rallied and stocks have fallen, offsetting the impact of lower treasury yields... the sharp correction in dollar/asia is telling in this regard.

Anonymous said...

C says'
thanks Skip.
However ,surely BB understands that people are not really buying the dollar so much as selling all things Euro correlated and as such what we have setting up here is a BB Fed V ECB + EuroCretins scenario where under the circumstances prevailing Eurocretins appear to trump most things anywhere inc the Fed.
Just my opinion of course ,but sell the cretins seems a sound tactic to me.

WellRed said...


Everything I am reading is telling me that Greece is already slipping significantly on their deficit YTD. Primary surplus next year strikes me as optimistic, but if it gets low enough (<2% maybe?), that may be enough to shift the cost/benefit analysis in Athens.

Food for thought.

Anonymous said...

Erm, isn't it pretty much certain that Greek sov CDS isn't gonna pay out? From where I'm sitting, being short this sh1tty product is the best trade out there (applies to pretty much all sov CDS, not just Greece).

Tradebot said...

LB, bang on re : new normal. Long slog ahead, given wages are stagnant and inflation will run above target for years to come, it is defacto wage cut for US workers. Good for productivity, but bad for above trend economic growth. When I mean trend, I mean the new trend ie. GDP growth of 1% , give or take +/- 1%.

Heh, I guess UBS should have not outsourced the control functions to India. It saved few pennies but cost few billion. They would have been better off outsourcing the front office to India and leave the back office in London!

Anonymous said...

C says'

I really like this one...

"They would have been better off outsourcing the front office to India and leave the back office in London!"