How Do You Spell W?

Wow.

Was yesterday a game-changer? It certainly carried all the hallmarks of one. The SPX broke its uptrend line off the March lows, and while that's only moderately interesting (given the number of similar such lines that have been breached during the 10 month rally), the fact that daily futures volume exceeded anything seen last year (even into the lows) was telling.

The catalyst, of course, was Obama's proposed "Volker Rule" to ban banks from owning/investing in hedge funds/private equity or even from proprietary trading. Now, Macro Man is hopelessly compromised here, as such proposals (if enacted) would be detimental to his profession.

And while it is probably imprudent to comment too much until the details are known, on the face of it such a draconian approach is both woefully misguided and appallingly naive. We can probably all agree that it's in no one's best interests to have a situation where a Lehman Brothers owns $50 billion+ in residential and commercial real estate turds, which brings down the firm and threatens the global financial system.

But there's a big difference between that and having a team of punters (not dissimilar to your author) who coordinate and utilize the market intelligence available to large banks (which is enormous and extremely valuable) to make informed bets in the marketplace. Trying to ban such activities will, in any event, almost certainly be doomed to failure, as swathes of prop guys could simply be stashed away on franchise desks. Indeed, part of being a good franchise trader is to have a view and take prop risk anyways, so how could the Federales credibly eliminate it when it is all part and parcel of "serving the customer"?

Moreover, let's not forget that it was proprietary trading- namely, the top-down decision to hedge against a subprime collapse- that helped save Goldman's bacon in '07-'08. Sure, the Feds stepped in when the crisis went nuclear, and yes that intervention to save the system may well have saved GS....but that doesn't mean that there was no utility to their top-down decision to take a "prop bet" to hedge against subprime.

In any event, Goldman's decision to donate $500 million to the Human Fund clearly wasn't enough to spare the firm from Obama's ire, let alone the public's. They clearly know which way the wind is blowing, however; the firm paid out just 36% of revenues in employee comp for 2009. That's loads less than other "human capital" intensive industries like sports or entertainment, and miles less than Morgan Stanley, which paid out 62% of revenues in employee comp. Morgan Stanley, incidentally, lost money last year, precisely because of these princely wage awards. Regardless, slashing the bonus pool to boost earnings did little for the GS share price; courtesy of Obama, the stock price fell sharply on its highest volume since last April.
Now, let's be clear: there is plenty to dislike about the way banks have conducted business over the past eighteen months, and things should change. Perhaps these proposals are simply a cack-handed way of re-introducuing Glass-Steagall (i.e., dividing banks into commercial and investment banks) without literally re-introducing Glass-Steagall. Perhaps they're even intended to encourage the likes of GS to re-privatize into partnerships. Macro Man has gone on record suggesting that both of these are desirable outcomes from a systemic perspective.

Surely the thing to do, however, is to impose top-down leverage limits and, within that construct, allow firms to get on with their business as they see fit. Trying to micro-manage the business of banking by creating lists of allowable activities is decidedly substandard. Of course, the policy was likely driven by populist impulses in the wake of the Democrats' shocking defeat in Massachussetts, and as we know the public's grasp of nuance leaves something to be desired (nearly 20% of the American public reportedly believe that the sun orbits the earth, for example.)

Regardless, when drastic populist policies are proposed (though perhaps not implemented; Macro Man's been surprised at the relatively unethusiastic legislative reaction thus far), the result is generally suboptimal outcomes. If yesterday really was a game-changer, perhaps it's time to start dusting off those W-shaped forecasts (or even the Cyrillic letter I shapes?!?!) for risky assets.

Rumblings of Chinese tightening do not help, nor indeed does the apparent waning of developed market growth momentum. The Citi major economy surprise index, for example, looks to be tracing out either a W or a И shape.
Hmmmm...a tepid economic recovery, a suboptimal, populist-driven policy reaction to a market crisis, and an equity dump after it felt like the worst had passed. How do you spell W again?
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Matt Johnson
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January 22, 2010 at 10:35 AM ×

i agree about partnerships being more desirable, as it gets around the limited liability problem of the company structure - however i strongly disagree about glass stegall.

a admit, i too am hopelessly comprimised too - i work for a global+universal bank & one that lost a LOT of $$ on this - however i think that this gives me some insight into the matter.

it was not our underwriting business that cost us. this is a fairly low risk business, and actually a pretty high margin business (esp equity IPOs).

what killed us was the rubbish in our liquitiy book. when the sht hit the fan, we couldn't repo the 'liquids' and when we sold them they went below our marks - which caused massive equity depletion.

there's was nothing in the GS act that would have prevented us from being so stupid.

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Macro Man
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January 22, 2010 at 10:41 AM ×

I think the point is that Glass-Steagall I-banks incur a much higher cost of capital and thus are unable to borrow/leverage as much as they have after the act was repealed. So in that world, the liquidity book would never have been permitted to get so large, because they wouldn't have been able to finance it.

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Matt Johnson
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January 22, 2010 at 11:06 AM ×

fair point re leverage, i was just trying to point out that the $$ we get for origination is pretty low risk.

this is sort of the point you make in your post - about operating leverage being the issue rather than activity x.

my substantive point is that the thing that really cost us was bad asset allocation. under any circumstances, we'd still have a liquids book. there is little that can be done that will protect banks from these sorts of poor decisions.

under any ciscumstances, we need cash on hand to run the business - and that means we've got to store it some place.

store it in the wrong hole, and it might go missing...

"honest gov, i'm sure i left that 50bn just over there, under that rock..."

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Crisis Management
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January 22, 2010 at 11:12 AM ×

Definitely the arch CB'er Volcker is back in from the cold. Did anyone notice the unseemly grins of Volcker and Biden as Obama began to deliver this volte face?

Volcker's lifting of the usury laws and his subsequent 20%+ rates constitute a dark chapter in the nation's history. He was despised at the time, and for good reason: A madman intoxicated by extraordinary power, determined to preserve the cohesion of Fed system at any cost.

The term "populism" has a slightly pejorative connotation. I personally do not subscribe to any ideology or movement called populism, but at the same time I do recognize that the TBTF bankers are crooks and deserve whatever they get.

However a resurgent Volckerism that seeks to punish only the bankers and not the true culprit, the central banks, is a dangerous tendency indeed.

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Matt Johnson
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January 22, 2010 at 11:23 AM ×

gotta disagree with you there CM. banks don't normally go around lending money to people who obviously can't pay it back - and to explain why they did is much more complicated than "rates were too low in 2003/4/5".

the problem was the micro incentives that the encouraged lending. if low rates were the problem, why is the japanese property market doing so badly?

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Anonymous
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January 22, 2010 at 11:29 AM ×

Ad stockpile management / started when commodities sub culture merged with inside-underwriters, later morphed into pushers of highly rated default swapped nothing - backed by nothing insured by nothing that was altogether prop shorted which then ended bailed out; and continued/s ever since on a growing scale… Explodes volatility into dried-up liquidity.

Moronstrocities aside I’d expect the new dynamics lining the existing Treasuries` holdings up for a remix, given window, Voldy has been waiting under, gets to open soon…

As for volcer scoring into larry s goal… many men turned mad when their IQ gets inflated by the “extraordinary power”, hence this ongoing IQ crunch.

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haruspex
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January 22, 2010 at 11:34 AM ×

Hopefully the Volcker rule is just a starting point.
The issue is how to define "prop trading".
In the narrow way, I agree with Macro Man that the rule would be useless.
But IMHO prop trading is also the running of vast risks, long term, e.g. the huge portfolios of CDOs, RMBS etc that blew up the banks.

The point of Glass Steagall should be to clearly define which banks will be guaranteed and helped when in trouble (the simple utility banks) and which one won't.

I prop trade myself, and hope that Volcker/Obama get it right, finally, and deliver the new, stronger Glass Steagall that we need, as well as the limits on size, leverage, etc.

I stop blurbing now, having blogged on it last night.

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Anonymous
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January 22, 2010 at 11:47 AM ×

Hi Macro Man - as you say this is a complex matter and we've got zero detail so far.

So, I just want to salute your even-handed treatment of the topic and hope that others on both sides of the debate do the same.

melki

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Darth Trader
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January 22, 2010 at 11:51 AM ×

Hi Macro Man,

Some of your points are valid but can we not just view this as an opening gambit from Obama.

Way I am thinking is that he has initially proposed a $90bn tax over 10 years on the big banks right? Since people seem to be fixating upon GS, let's assume for argument's sake they are liable for 10% of this, so $9bn over 10 years = $900m a year.

Now, the average net income GS reported from the start of the noughties to the last of the glory years was about $5.3bn by my reckoning - so what he was suggesting would effectively have been a 17% tax every year for a decade.

You can kind of understand them (and the others) being somewhat irked at this suggestion, but as always they do themselves no favours by the way they conduct themselves and the chimps in the mainstream media then whip up a frenzy, "arrogant bankers, etc, etc".

Probably Obama can see that trying to talk them into handing over 17% of earnings for a decade is a pretty hard sell, so instead he opts for the Hiroshima option - hard but ultimately effective.

Maybe I am reading this totally wrong but I would imagine they have no real intention of actioning this proposed regulation - it must be just to get them all to the bargaining table to discuss constructively whether $90bn will actually end up being $150bn or $10bn or whatever the final figure may be.

FWIW I am not unsympathetic to the underlying point - if you want to punt around fine, but not with taxpayer money. And the argument "but we have paid it back" is of course bogus - insurance doesn't come for free.

Your points are mostly valid though - micro-management must surely be seen as a bad idea, and anyway there is always a way around this type of regulation when the definition of prop can be made to seem so opaque, examples of which you have pointed out.

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Anonymous
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January 22, 2010 at 11:52 AM ×

The new GS / prop ban does not deal with the fact that turds continue to pile (OTC) under our butts as we speak... Yes we can (shoot hot air on prop trading)! But no – can’t touch the turd machine…

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Charles
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January 22, 2010 at 11:53 AM ×

'how could the Federales credibly eliminate it when it is all part and parcel of "serving the customer"" ?

"serving the customer" can be done very effectively through listed securities and futures only, especially if one is a macro punter. Without the obstruction of the banks, futures could be extended to corporate bonds easily (makes much more sense than credit swaps anyway). Market making has been provided by locals using their own capital for decades and the system worked fine.

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Anonymous
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January 22, 2010 at 12:01 PM ×

dubya (lol)

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Donlast
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January 22, 2010 at 12:07 PM ×

The message post-Brown is that ALL incumbents now have to watch their backside, Republicans as well as Democrats. Voter anger in America is now visceral and palpable and rational discussion of pros and cons just will not wash. If bankers have to hang out to dry they will be hung.

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But What do I Know?
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January 22, 2010 at 12:27 PM ×

Good point about the minimal amount of comp as a % of revenue paid by GS. MS's retail division turned their assets at 80 bps (respectable) but the profit was only 4/10 of 1% of AUM(annualized). Seems kinda low if I'm a shareholder (which I'm not). . .

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Anonymous
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January 22, 2010 at 12:31 PM ×

I think to ban proprietary trading, fx, rates and credit all would have to go the way of futures and stocks and become agency products with commissions attached ?

Like that will ever happen ? Transparency ? No thanks !!

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Macro Man
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January 22, 2010 at 12:49 PM ×

Matt, I hear what you're saying re: short end books, but I'd submit that without the veritable Everest of ighly levreaged turds sitting on and off banks' balance sheets, we wouldn't have seen the LIBOR blow outobserved in 07-08....or at least not nearly to the same extent...in which case the short end books would have done OK I think. The blowout in LIBOR was the ultimate condemnation of excess leverage in the system.

Darth...bear in minbd that the Obama "bank fee" gig is a function of liabilities rather than profits/fixed numbres...so a delveraging cycle/eliminating TBTF will, in all likelihoo significantly reduce the amount of incoming revenues. Insofar as shrinking bank size/leverage is an overarching policy goal, it's not bad I suppose as an incentive. Where a privately held GS fits into that, I have no idea.

haruspex, to my mind if you effectively limit leverage and pre-determinbe who gets help and who doesn't, you put in place an incentive structure (via cost of capital restraints if nothing else) that will limit turd-buying...so there's no point in banning individual acitivities. Let the banks decide what they want to spend their newly-precious capital/leverage on.

As an aside, I've not read very much at all about the Supreme Court decision allowing corporatations, unions, etc to go crazy in donating to politicians' campaigns. So while Obama has neatly taken aid at those naughty, greedy bankers, politicans will be able to feather their own nests more than ever before. It's a disgrace...but sadly, the US political system delivers the policymakeers that it deserves.

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Anonymous
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January 22, 2010 at 1:06 PM ×

Go on Obama, you're killing USA... what's NY without finance??
This proposal is completely nonsense according to me....
however GS stock price is a good proxy for our career's NPV... and it's not actually well positioned...

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Anonymous
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January 22, 2010 at 1:12 PM ×

Meanwhile, the people s bank wants to »improve RMB's exchange regime”. Everyone - short more silver!

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Kevin S
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January 22, 2010 at 1:21 PM ×

This is only one of volcker's many recommendations to the president and he one of the most respected economists in the world (he is also at odds with ben and tim)

The principle is hard to argue with: why should firms that have access to the social safety net be allowed to take on substantial proprietary risk with that money?

Between FDIC deposits, past and expected bailouts, zero percent interest rates, and modified accounting rules, wall street should be thankful they are still around.

We buy them time so they can earn their way out of the mess that is their balance sheet and they go on paying bonuses? they should be using every cent to write down debt that they aren't writing down (look at commercial real estate loan portfolio)

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Steve
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January 22, 2010 at 1:30 PM ×

I'm a bank prop trader at a non-US bank, for disclosure.

Did prop trading have ANYTHING to do with the crisis? The only house that I can think of that was significantly impacted by their prop desk was SocGen, and that was from fraud.

I am not an expert in how all banks organize themselves, but I don't know of any prop desks that had material positions in the nuclear turds that brought us to the brink. The credit crap was much closer in spirit and design to bank loan books, or so-called "investments," bought, held, and forgotten.

The nuclear meltdowns were in the SIVs (you call those prop?) and in the residual pieces of CDO and CLO deals that needed to be moved. It was in "Super AAA" permaturds that came at libor + 35 (AAA? HELLO!!) and that could never be resold.

The list of problems is long but none of them lead back to prop desks.

Which desks are going to buy treasuries at 3.60% and fund THROUGH THE REPO MARKET, NOT the Fed, to get the carry banks need to recover? What will happen when prop desks don't show up at the auctions and we have to rely on the Chinese to buy them at higher yields?

Who ultimately is going to provide liquidity to hedge funds once the prop desks are shuttered? Banks are the reinsurers of hedge fund liquidity. Who is going to take the other side when Ma, Pa, and Mrs. Watanabe decide it's time for risk-off?

Hadda rant. Great post. So much for even-handedness, melki.

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Romandière
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January 22, 2010 at 1:41 PM ×

drastic populist policies?
last year it were drastic elitist policies and I heard nobody shouting back then
but basically I agree with you; just let the banks pay back everything right away and let's forget about it

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January 22, 2010 at 1:45 PM ×

I'd be surprised if reducing leverage worked as well as people hope (in much the same way it didn't particularly work for Merriweather). As:

- "Liquidity" books are generally illiquid (and thus normally negatively skewed).
- Incentive structures (as at hedge funds) encourages maximizing of short-term returns (and thus probability of future blow-up)
- Risk models inherently and systematically underestimate risk in times of stress (and risk models only matter in times of stress!)

Given the first and last won't change any time soon, I suspect for reducing leverage to be really effective you also have to change the incentive structure (more stock & longer vesting period).

GS: imho, would have been down a ton a chunk anyways yesterday. Compensation was too blatantly obviously a PR move (negative comp in Q4?).

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Anonymous
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January 22, 2010 at 1:45 PM ×

Steve, you're right, but there are different ways to manage a prop desk.. some had done BIG mistakes..
But for example isn't to buy a corporate bond the same thing that to make a loan to a firm? isn't this the principal role of a bank?
Or to manage the classic interest risk of loan book isn't the same that to take a prop risk (curve risk for example??)
They really understimate the role of prop desk (and money) on financial markets... at least they'll pay the consequences, surely!!
and then for example: i can't buy hedge funds, but can i buy their UCITSIII version so in-vogue lately? why a hedge fund is riskier than a total return mutual fund or also a long-term bond benchmark mutual fund?

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Anonymous
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January 22, 2010 at 2:09 PM ×

"But there's a big difference between that and having a team of punters (not dissimilar to your author) who coordinate and utilize the market intelligence available to large banks (which is enormous and extremely valuable) to make informed bets in the marketplace. Trying to ban such activities will, in any event, almost certainly be doomed to failure, as swathes of prop guys could simply be stashed away on franchise desks. Indeed, part of being a good franchise trader is to have a view and take prop risk anyways, so how could the Federales credibly eliminate it when it is all part and parcel of "serving the customer"?"

This is precisely the type of activity that should be banned. Banks have a priveledged position and dealing desks should not be taking principle positions given the knowledge they have of client activities, their seniorsmanagers market knowledge of investment banking client activities and trends, and their senior senior managers knowedlge of government thinking and plans (eg end of 08 start of 09). Bring back single capacity, destroy the massive conflict of interest that has always existed in US banking.

I work in prop.

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Macro Man
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January 22, 2010 at 2:13 PM ×

Anon @ 2.09, perhaps one might have an argument restricting activities in certain regulated markets where Chinese walls exist, but in unregulated markets like FX, where the notion of inside information does not exist, and sovereign entitites routinely run over bank franchise desks, I see no problem with it whatsoever.

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Macro Man
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January 22, 2010 at 2:14 PM ×

Steve, i think Obama/Volker WOULD call the SIVs "prop"....which is why the announcement called for a blanket ban.

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Anonymous
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January 22, 2010 at 2:36 PM ×

As a flow trader for many years, I have spent many hours telling compliance that most of my trades are "pre hedges" for future custy transactions. With compression of spreads in many markets, most flow traders earn their real money from prop. Banks may very well close down "prop groups" but just move the risk to flow groups and have the new "flow traders" engage in constant "pre-hedging" for future flow.

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Steve
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January 22, 2010 at 2:59 PM ×

Yes MM, they probably would, but then they had better call loan portfolios and mortgages "prop" too, not to mention the entire treasury function.

I want to see the details but I don't like the way it's going.

Looks to me like they trotted out the closest thing they had to a Republican to distract us from Scott Brown. Hopefully cooler heads will prevail in a few news cycles.

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zanon
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January 22, 2010 at 3:04 PM ×

Macro: Hopelessly compromised indeed. Are you really claiming that prop trading should be given a taxpayer backstop?

Geither and Bernanke just cost Obama his healthcare dream. And it's not going to get any better. More to the point, "what's good for the banks is good for the economy" has been obviously and massively falsified. SPX up or down, unemployment is at 10% and will get worse.

You seem to have not noticed -- the US is in an L. There is no W as there has been no V. The SPX is not the economy.

Also, read some of your older posts! SPX was due for a crack up for ages.

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Charles
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January 22, 2010 at 3:37 PM ×

Steve, Kerviel was working for a flow business, and not a sophisticated one at that (it was not called "delta one" department for nothing).

When you say "Which desks are going to buy treasuries at 3.60% and fund THROUGH THE REPO MARKET, NOT the Fed, to get the carry banks need to recover? What will happen when prop desks don't show up at the auctions and we have to rely on the Chinese to buy them at higher yields?"
you sound like the banks are making a favor to the Treasury. It is the reverse way round my friend ! The taxpayer would be much better of borrowing at 0% than at 3.6% to clean bankers's mess. The treasury doesn't need the Chinese to buy its debt, Federal T-bills are legal tender.

Who is going to take the other side of trades ? There is always a price at which the market clears, even for the worst turds, you don't need bank sponsored liquidity for that.The 2008 events showed that bank liquidity is not there when one needs it, even when refinancing at the central bank is available.

Lots of people are angry in this comment area because Volcker is telling them that they have no clothes.

Anon @ 2:36 : explain the difference between "pre-hedge" and front-running. As an aside, this is why listed markets (without flash orders) are much preferable !

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Anonymous
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January 22, 2010 at 3:39 PM ×

Hi,
I was wondering if you could tell me where you got your stats of employee comp. and all your stats. about the firms and markets from- I am a student and loves to analyse stats. to make my own judgements- Not that I don't like your analysis, it's just that I want to make connections and deduce trends for myself. It would be great if you could tell me some websites that are useful. My email is: Y.Zhang@2008.hull.ac.uk Thanks!

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Anonymous
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January 22, 2010 at 3:56 PM ×

But the sun does orbit the earth...let's assume Obama, despite the populist posture, is smart (which he is). Then as pointed out, and as a shrewd politician we can assume this agenda makes great press and rattles the very heart of the capitalist system. But really, let's look further than the end of his nose. He knows the entire system was built on risk taking- America's preeminence and growth are based upon such flexibility- and also has people on his side that, whatever the ideological bent, are no fools.

If we assume he's not asking to scupper the capitalist system then we have either alternative agendas being administered to, including health care, while trying to steer public consciousness into a more humanitarian moral sphere. After all he did win the Nobel Peace Prize (lol).

The neocon's agenda was world domination and enriching themselves to the detriment of everyone else, regardless of morals or ethics ( remember, "a vote for the democrats is a vote for the terrorists!"). Obama's smarter (ok a LOT smarter), but no less focused however and this entire entreprise provides an opportunity to shape public sentiment, focus on the misshapen policies and recklessness of the prior administration while fueling the political capital to support his mainstream agenda.

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Steve
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January 22, 2010 at 3:56 PM ×

I don't know, looks like we'll all have to agree to disagree on this. One thing's for sure, it's open season on flamingos, and as Brad Pitt said in "Inglorious," business is boomin'.

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Anonymous
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January 22, 2010 at 4:04 PM ×

To be fair the question they asked in the Gallup poll was "As far as you know, does the sun revolve around the earth or the earth around the sun." If I read that question I'd wonder why they bothered to preface with "As far as you know", and think they were maybe asking me to answer it from "my perspective", which is of course that the sun revolves around the earth. Unless I flush a toilet or something, which would prove I'm in a rotating reference frame. Or maybe the preface just wanted to ensure I didn't ask someone else, like not "as far as your physics teacher knows".

Or perhaps I've been too traumatized by recent markets and can't even answer a simple question anymore.

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Crisis Management
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January 22, 2010 at 4:34 PM ×

Matt Johnson, ahem, Japan already had the property bubble to end all property bubbles... in the 80's.

Not sure what you mean by "micro incentives" causing the bubble, you mean like the free toaster with every no-doc loan?

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Gary
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January 22, 2010 at 4:39 PM ×

MM (and others), I don't know if you work for one of the big "evil" banks in question, but your opinion does seem more than a bit compromised.

There is absolutely no merit in allowing trading desks to make simple markets (never mind "pure" prop bets) using taxpayer money -- and all the PR spin in the world will not fool anyone. The banks are borrowing at FF rate and using it to trade. The Masters of the Universe really sound like whiny little girls when they bitch about having to borrow at market rates.

Prop trade as much as you like, but do it with your own capital, or with money you borrowed at market rates (not taxpayer subsidized rates).

As for Glass-Steagal and such -- we have all heard this synergy nonsense before. The banks with the most "synergy" (RBS, Citi, etc) are the ones in the most trouble.

The facts (as opposed to the theory) are that competent management cannot be experts in all fields. Specialization has proven the dominant strategy in every industry -- including finance.

Having said that, its very obvious that big banks do NOT attract competent managers -- they attract politically savvy managers. Whatever their skills are at Machiavellian politics, they clearly lack in things like risk management and understanding the business.

Universal banks lack the specialization to understand the risks on their books. Management cannot be a jack of all trades. And even qualified traders have a lot of trouble trying to guess the correct hedge ratio / beta between different asset classes. Plenty of good traders have lost money as a result.

Allowing someone to massively lever up a book where the hedges are unknown (and unknowable) doesn't make any sense -- which is why partners in a partnership don't allow it when they are trading with their own money.

That shareholders permit this is evidence of severe agency problems. That regulators allowed it is evidence that academics like Bernanke have never traded outside the theoretical class room exercise.

Allowing that leverage to be done using taxpayer funds and taxpayer backing? Expecting regulators that are hopelessly compromised will keep an eye on things? You can't possibly think this will result in anything other than regular financial crisis.

Senior partners at the old Goldman Sachs (who actually understood the risks) never allowed the amount of leverage that all the banks used ON BOOK, never mind through SIV's.

Even if the Fed/Treasury weren't stuffed with Goldman people, its very doubtful they would ever have the expertise to understand a firm's books as well as partners inside said firm.

Some voters may think the sun goes around the earth, but they aren't stupid enough to buy into the "heads banks win, tails taxpayers lose" idea.

Citi and Goldman can borrow at 0%, but Exxon (which is a vastly better credit risk) has to pay 3.5% short term? That's not capitalism.

Warren Buffet is a smart guy -- he didn't lend HIS money to Goldman at 0%, he charged 10%. Only an idiot or a corrupt politician lends to inept bankers at below market rates. It just makes no sense at all.

I don't care for Obama's populism, but the industry needs to get fixed. The entrenched morons running the big banks are too busy counting their million dollar bonus packages. They have failed to do their job again and again.

A free market would have taken capital away from these idiots years ago. The US/UK need to return to capitalism. Allocating risk capital based on who Paulson / Geithner / Gordon Brown play golf with is not capitalism.

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Macro Man
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January 22, 2010 at 5:17 PM ×

Zanon, Gary,et al: where have I claimed that prop trading should be given a taxpayer backstop? Nowhere.

Listen, the TARP was welcomed by some banks but forced on others...who subsequently paid it back at the first opportunity.

Banks should be forced to operate within leverage limits...but within those limits, which should be set at levels that preclude the necessity for future bailouts because of systemic risk, they should be allowed to get on with their businesses as they see fit.

What do you suggest that a bank does if it sees a likelihood that some aspect of its business is threatened? Put on an offsetting position using its own capital, or bend over with a smile because ideologues such as yourselves say 'no prop trading, sunshine.'

Gary, I have never worked for a US bank but have worked for a fund partially owned by a bank. The market does NOT need Obama, Brown, or you to say that banks should unilaterally jettison those investments. Believe me, the market applies its own pressure to do so.

Your cartoonish belief that everything and everyone associated with banking is inherently immoral/stupid/crooked/on the take/whatever is both well-known and wrong....as indeed are all one-dimensional arguments, as well as your apparent willignness to absolve Joe Twelvepack for his responsibility in the financial crisis.

Zanon, Bernanke cost Obama health care reform how, exactly? Did he single handedly provide all of the negative votes in opinion polls? Is he also to blame for global warming, El Nino, the scarcity of the spotted owl and the lack of a salary cap in baseball? He's got enough to be blamed for without heaping health care on his shoulders as well.

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Gary
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January 22, 2010 at 5:20 PM ×

BTW -- it bares mentioning that bitchy whiny traders were very much against Volcker when he raised interest rates to double digits in the late 1970s / early 80s. Investment banks predicted the end of the world was upon us if Volcker wasn't stopped.

In hindsight, Volcker was praised, but at the time, the investment bankers could say nothing even civil about him.

Volcker prevailed over the investment banks, and two decades of falling inflation and economic prosperity followed.

Even the banks benefited from Volcker's "foolish notion to raise interest rates".

There are lots of details that remain to be seen with this new proposal -- but Volcker has shown he has forgotten far more about economics than the top Wall Street banks ever knew.

He has demonstrated willingness to accept some short term pain (even ridicule) to get massive long term gains. I think they call that investing?

And lastly, Volcker appears to want to help the economy as a whole (even if he doesn't succeed) -- Geithner is clearly out to help Goldman and only Goldman. Larry Summers and Bernanke are just clueless.

I don't know if I should trust Volcker -- but I am 100% certain that I do not trust Geithner.

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Gary
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January 22, 2010 at 5:35 PM ×

MM: The market does NOT need Obama, Brown, or you to say that banks should unilaterally jettison those investments. Believe me, the market applies its own pressure to do so.

Quite obviously, this is not true or we wouldn't be talking about TARP at all. And even if it was true, central bankers have insulated bad banks from all market pressure.

MM: Your cartoonish belief that everything and everyone associated with banking is inherently immoral/stupid/crooked/on the take/whatever is both well-known and wrong.

A "bank" has many components. Many individual employees are noble and try to do their best. Historically, managers were selected *mostly* on the basis of merit. A few cronies got through as happens in every organization, but it was mostly merit.

Recently, bank management has been decided almost entirely by cronyism. Sandy Weill (Citi) was an insurance guy -- he had no background in commercial or investment banking. Chuck Prince was a lawyer, and his solution to problems was to tell everyone to get up and dance. Fred Goodwin was an accountant / consultant who armchair quarterbacked, but never actually ran a bank before becoming CEO at RBS. The list goes on and on.

Others, like Dick Fuld at Lehman, had a background. Fuld seems like a smart guy -- so why did he tolerate so much leverage? Was it greed?

Still others, like Stanley at Merrill and the Bear Stearns guys were busy playing golf / bridge while their firms collapsed. Fiddling while Rome burns is not a sign of competence.

Then we have Goldman. They gave us Rubin (who convinced Clinton to legalize CDS). They gave us Thain who bought himself a $35K toilet while the firm was essentially in receivership. They gave us Paulson, who presided over the AIG trades when he was at Goldman and later covered up his mistake using taxpayer money.


Clearly, bank management in recent years did not behave the same way as those who ran the partnerships of yester-year. When its your own money on the line, you are a lot more careful than when you risk other people's money

Cronyism needs to go. Meritocracy needs to come back. Capital needs to be allocated by markets, not politicians.

Nothing I am saying is new -- its how the markets worked for decades

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Mannwich
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January 22, 2010 at 5:47 PM ×

Excellent points, Gary. Hard to disagree with any of that.

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Macro Man
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January 22, 2010 at 6:09 PM ×

MM: The market does NOT need Obama, Brown, or you to say that banks should unilaterally jettison those investments. Believe me, the market applies its own pressure to do so.

Gary: Quite obviously, this is not true or we wouldn't be talking about TARP at all. And even if it was true, central bankers have insulated bad banks from all market pressure.


Gee Gary, how much first hand experience do you have in these dealings? You can pontificate all you like, but I have been involved in these situations. What I assert is in fact the case, because I have have lived through it.

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Gary
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January 22, 2010 at 6:23 PM ×

MM - I used to work at a major sell side bank before switching over to the buy side in disgust.

I resented being asked to fire my junior trader, who paid his dues and was smart -- and then two months later I was told to hire the son of a friend of the CEO who was fresh out of college (never paid his dues) and was a rank idiot.

I was asked to take positions from the securitization group and hedge them -- and when I didn't want to do that at a loss (subsidized by my trading), that's when the crony kid (still with a whopping 4 months experience) was given the support tranche hedge book entirely. The book size exploded -- and it eventually was one of the major losses for this bank.

I am speaking from experience. I left because I didn't want to be part of the nonsense -- and I deeply resent Geithner trying to force me back in against my will

Let the "bankers" pay for their own mistakes. They knew exactly what they were doing.

Heads they collected a bonus, tails the shareholders /taxpayers took a loss.

That's not banking and its not capitalism

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Anonymous
admin
January 22, 2010 at 6:27 PM ×

Macro Man: why are you so worked up about a proposal in the United States? Don't you work in the UK?

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Macro Man
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January 22, 2010 at 6:35 PM ×

I work in the UK..in a global industry. Things which damage people of my ilk in the US can very easily damage me. George Osbourne is making supportive noises about the policy. I am also a US citizen and taxpayer, which I suppose also grants me the right to have a view.

Are large banks badly managed in certain areas? Sure. But so is every single large organization out there. Do I support TBTF are morally hazardous bailouts? No, not really

But banning prop trading and ownership of investment management businesses is not the solution to the problem. Restricting leverage to systemically safe levels is. What that has to do with Gary's junior jubbo assistant is frankly beyond me.

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haruspex
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January 22, 2010 at 6:50 PM ×

Macro Man:
<<
haruspex, to my mind if you effectively limit leverage and pre-determinbe who gets help and who doesn't, you put in place an incentive structure (via cost of capital restraints if nothing else) that will limit turd-buying...so there's no point in banning individual acitivities. Let the banks decide what they want to spend their newly-precious capital/leverage on.
>>
Note that when we say:
"predetermine who gets help and who doesnt"
we are effectively saying the Volcker rule.
If you take market risk, you should not get guarantees or bailouts.
In other words, you should not be a bank, as banks get guarantees and bailouts.

That's the essence of it.
What worries me, is that they will do it badly.

Done properly, it wouldnt hurt prop trading. It would just move it where it belongs.

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PPM
admin
January 22, 2010 at 6:51 PM ×

MM: Come on! TARP and all of the monetary hocus pocus massively ramped the marks on all assets, which benefited all of the banks, regardless of whether or not they were direct recipients of cash. It was a transfer of wealth from taxpayers and savers to clueless bank bondholders, and judging from the bonuses, management also. That is capitalist? That is banana republic style redistribution of wealth to the elites with the most influence.

If we had let the banks go under, THAT would have been capitalism.

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Gary
admin
January 22, 2010 at 7:07 PM ×

MM: Restricting leverage to systemically safe levels is. What that has to do with Gary's junior jubbo assistant is frankly beyond me.

Seriously MM?

My junior guy, like myself, was unwilling to try to hedge the subordinate tranches from all the deals the securitization group was making. Obviously, securitizing toxic waste was a huge money maker as long as you pretended the risk wasn't there.

Every bank bought the toxic waste, put it in a REMIC/CDO/ABS whatever and sold off the senior tranches. The subordinate tranches stayed on the banks books and were hedged.

When the volume of deals got high enough, the true cost of hedging increased. Experienced traders of course wanted to pass that cost back to the securitization desk -- which would have made many deals less profitable if not unprofitable.

The solution was two fold -- "promote" the senior traders to some other department, get rid of the trained staff, and bring in yes men straight out of college. The newbies wouldn't realize the risk, much less the cost of that risk. They would be happy to book the accounting profits; that they were massively short gamma didn't bother them in the least.


Essentially, these guys were making money by being short straddles in size -- often 20-25 times the banks capital. As soon as there was any volatility, the banks were finished.

Later, the garbage was put into SIVs to conceal the risk (and its size) from the banks' balance sheets. To add fuel to the fire, the short straddles were "financed" with overnight money that would be pulled if (when) the risk became known.

Experienced traders knew this and didn't want their deferred compensation to get hit (deferred comp used to be common in many firms). So management replaced them with crony newbies were happy to go along.

The "banking" crisis occurred in 2003-2004 when these short straddle positions became many times larger than the banks themselves. It wasn't until 2007 when the accounting caught up to the risk

My former junior guy is doing quite well now at a hedge fund. The newbie the bank managers put in is now selling sunglasses in Florida. And the bank is now one of the many zombie banks being propped up at taxpayer expense

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Gary
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January 22, 2010 at 8:07 PM ×

BTW Macro Man -- I have no idea how many bank CEOs tried to conceal their problems versus how many simply didn't understand the risk was on their books. I suspect (but could not prove) some of both.

Regardless, if you understand the culture / politics of big banks, then you know the department that is generating massive profits often runs the place. If the CEO "stands up to them", they mutiny and the CEOs job is in jeopardy -- either the group leaves and the firm's profits drop, or the group goes to the board of directors to get the CEO fired.

And there is no way to prove beyond a reasonable doubt that the securitization group really understood the risks -- they just knew one trader was willing and another was not. It sounds bad in 20/20 hindsight, but you can't prove anything beyond a reasonable doubt (i.e. in a court of law).

Even knowing my ex-CEO for years, I couldn't say for sure what he was thinking.

The corporate culture of big banks is why they should not be allowed to prop trade -- the culture prevents good risk management.

Private partnerships err on the side of being a little too cautious -- its their own money they are risking on something they don't understand.

Deferred comp systems only work if management doesn't have lucrative severance packages and if the comp is deferred many years (until the assets mature).

Big banks risk / accounting is decided by committee -- so its quality is completely politics. Ultimately, you have to decide whether to pick a fight and lose YOUR job; or do you keep quiet and let the suckers (aka shareholders) take the hit. Its a classic agency problem

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zanon
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January 22, 2010 at 8:21 PM ×

Macro: The financial system, as it exists today, is more trouble than it's worth. I don't blame bankers for being greedy, they are products of their environment, and the environment has created a predatory banking system.

Bernanke and Geithner cost Obama healthcare because they presided over a banking sector that blew up and generated 10% unemployment, which cost the Democrats Massachussetts. Massachussetts! You know full well how this works.

The point of banks is to make loans that get paid back. That's it. The other stuff should not happen within the context of a bank, and there are plenty of other vehicles for it. Banking gets the taxpayer backstop, the rest of the financial system does not, as the liability side of the balance sheet really is no place for market discipline. The regulatory framework on the asset side should enhance everything that makes banks care about credit risk, and outlaw everything that dulls that focus.

People talk about the Great Depression, but really, Japan is the right model. Do you know any Macro guys who work there? How is it? I think that's the best glimpse into our future.

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leftback
admin
January 22, 2010 at 8:31 PM ×

Busy here today, innit?

LB has enjoyed the week, although he wonders if the Volcker Plan might not end up being just a bit of Kabuki theatre of the type Washington enjoys so much. Anything that doesn't happen until 2013...?

MM is right, it is about leverage and the quality of assets. Turds may be held, but necessarily with higher levels of reserves and lower leverage than quality assets. It is hard to see how the credit markets would work without any prop trading.

Buy side and HF guys going at it a bit today.... just like old times. Easy does it, MM, you would have given me a yellow card for clattering into Gazza with yer studs up... then again it's your blog !

Of course this all happened with China, Greece and other undercurrents that are conspiring to lift the dollar. We had a great trading week, and my very special thanks go out to the punter who told me to "go ahead, short some silver, I DARE YOU", which obviously we did.... quite profitably too, I might add !!!

No doubt said punter will be back next week, like the Black Knight , bleeding profusely, but maintaining stoically: "It's Only a Flesh Wound.."

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Willy
admin
January 22, 2010 at 8:32 PM ×

Zanon: lets be a little fair with Massachusetts and health care.

Barney Frank is from MA and was instrumental in screwing up FNMA and FHLMC. He repeatedly blocked efforts to better regulate these firms. Frank wanted to increase home "ownership", even if the marginal buyer couldn't actually afford the home. Frank was as blind to known risks as the bankers.

Second, the country could never afford the massive entitlement expansion that Obama was trying to force on us. We couldn't afford it even in good times. We already cannot afford the "cheaper" system we have now.

Everyone can already get health insurance -- even the "uninsured". They just can't afford it.

ObamaCare wasn't going to solve that anymore than Barney Franks was going to stop FNMA from taking on risks neither he nor they understood

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leftback
admin
January 22, 2010 at 8:45 PM ×

Zanon:

Agree with you 100% about Japan, that's the model we have been working on and we have avoided all the big mistakes, while making many small ones.

Disagree with you 100% about prop trading. Think of the role of the broker-dealers in the Treasury market and then think about the muni market, and you can see that the banks can play useful roles and are often critical in ensuring markets remain liquid. The key is to have limits on leverage.

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Willy
admin
January 22, 2010 at 8:55 PM ×

leftback: we need limits on leverage, but we also need limits on taxpayer subsidies and backstops

If you want taxpayers to provide banks with free spread "profits" (eg 3m -10y) then it would be fair to tax them a like amount. Its not their money in the first place.

And if you want taxpayers to provide banks with a market put (bailouts) -- then absolutely positively the banks should pay for that option.

The problem MM won't admit to is the price of that option exceeds the profit margins available to an industry with massive overcapacity.

Without these two subsidies, most banks (not all, but most) would cease to be. Paying million dollar bonuses out of taxpayer subsidies is morally wrong and bad for the economy. Its how banana republics happen.

When Glass Steagal is reinstated and/or prop trading is banned -- banks will have to downsize to a self sustaining size. Without taxpayer subsidies, they cannot maintain their current size.

Bankers understand this ramification just fine, which is why they oppose the measure. Its not about economics or market liquidity -- its bankers knowing that their industry is destined to shrink without taxpayer subsidies.

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Willy
admin
January 22, 2010 at 9:01 PM ×

Leftback: Think of the role of the broker-dealers in the Treasury market and then think about the muni market, and you can see that the banks can play useful roles

The very same banks that make markets in Treasuries (with a lot of help from the Treasury) are the very same banks that make illiquid markets in munis

Other than the lack of Fed subsidies, why don't the banks offer the same liquidity for munis?

And why do banks regularly sell municipalities complicated swaps that even Goldman Sachs alum Jon Corzine said he couldn't understand?

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leftback
admin
January 22, 2010 at 9:03 PM ×

No arguments here on bailouts, Willy.
If you smoke, you choke.

Not much of a flight to quality today in credit markets, MM, or even a "flight to quantity" as Gary would put it.

Not THE BIG ONE, not yet, is our guess ?

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Gary
admin
January 22, 2010 at 9:21 PM ×

leftback -- with the monkey of that pension fund off my back, I have joined your game of trading a small prop book (with my firm's money, not the taxpayers).

I have been short crude for a while. Still won't touch the certificates of confiscation. While I see your points on technical trading levels, the political risk of Treasuries is very high.

If Geithner doesn't give your money to Goldman, Volcker will make levered money liquidate. Its an unstable system, and the bureacrats will need to make increasingly desperate changes to keep all the balls in the air.

If Volcker's idea passes *as he stated it*, I think its a good start. I do fear how Congress might "re-interpret" his idea, especially in an election year. Especially when Nancy Pelosi and Barney Frank are doing the re-interpretating (that's not a word, but...)

As for your equities / credit ... they are up on last year's thin volume (subtract out the algorythm trading, which is noise). Me thinks the banks -- sorry macroman EVIL EVIL EVIL banks :) -- have been marking their inventory high.

Retail didn't buy the recovery, and doesn't trust what is perceived as a rigged market. Retail bot bond funds, leaving the banks with overpriced equities financed at FF rate, which now looks like it might become a higher broker's rate. Last bank through the exit door gets stuck with inventory and a loss!

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Willy
admin
January 22, 2010 at 9:45 PM ×

Ah ha! Gary wants the over levered banks out of prop trading because he wants them playing on the same terms as him -- without taxpayer subsidies

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zanon
admin
January 22, 2010 at 9:56 PM ×

Willy: If Coakley had won MA, as everyone thought 2 weeks ago, Volker would not have been standing next to Obama yesterday. Case closed.

Leftback: I am with you on capital controls being absolutely required. They are not enough though.

I don't see why muni markets are in any way incompatible with what I said.

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Willy
admin
January 22, 2010 at 10:08 PM ×

zanon: If Coakley had won MA, as everyone thought 2 weeks ago...

Where do you get off with this "as everyone thought" nonsense? How arrogant!

Perhaps you meant to say the news media, which (except for Fox) is extremist liberal, expected her to win.

Perhaps you meant the people in Washington DC, especially the Democratic National Commmittee, which took the seat for granted and stopped caring or even wondering what "we the people" thought.

Perhaps you meant Nancy Pelosi, who felt she could negotiate the health plan behind closed doors? I have little doubt she thought and still thinks she is above the law.

Perhaps you meant Harry Reid, who openly bribed the Senator from Nebraska to get the unpopular Senate bill through? No doubt he thought there would be no ramifications to bribing a member of Congress on national TV.

But if you meant the people who were going to get the bill for all this government stupidity, then you are obviously wrong: she did lose.

If you meant the 60% of the nation that opposed ObamaCare (at least as proposed) -- they fully expected the loss.

If you meant anyone who watched the incumbent losses in November 2009, they fully expected the loss.

If you were watching Chris Dodd opt not to embarass himself by running a campaign he could not win -- then it wasn't hard to foresee a problem.

You seem to have a very liberal viewpoint -- and YOU might have **HOPED** Coaxley would win. Your hope is not the same thing as everyone's opinion. Neither you nor the DNC speaks for the rest of us

According to polls, fully 60% of "us" don't want ObamaCare. Pelosi and Reid (and Obama) are supposed to represent the majority, not extremist nut jobs

Obama is simply re-remembering that the majority rules in a democracy, not the extremists

Do not be so arrogant as to try to speak for the rest of us. You expected Coaxley to win. I expected a backlash.

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Anonymous
admin
January 22, 2010 at 10:26 PM ×

@zanon "EVERYONE" thought?

Oh my God! Did you think about that before you wrote it? Everyone? As in 100%? Did you go around and actually talk to *EVERYONE* in Massachusetts or are you just assuming your opinion (and perhaps a few of your like minded friends) was "everyone"?


George Washington did not get 100% of the popular vote.

Abraham Lincoln never got 100% of the vote.

FDR never got 100%. John F Kennedy never got 100%. Ronald Reagan never got 100% of the vote.

Heck, Edward Kennedy himself never got 100% of the vote. Ted Kennedy himself never had "EVERYONE"'s support!

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Ian
admin
January 22, 2010 at 10:39 PM ×

The arrival of the political zealots means its time to hit the bar for the evening.

Curious the lack of reaction in Treasurys, FX today.

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Willy
admin
January 22, 2010 at 10:44 PM ×

Sorry for jumping on your case Zanon, but your attempt to portray your viewpoint as "everyone's" is very offensive. I think your attitude demonstrates why Coaxley lost.

Obama himself said the very same anger that got him elected a year ago, also got Brown elected today. The political elitists, with rather extremist views, who think they are the country.

We did not elect Obama so much as we rejected Bush's extremist right wing ways. We rejected him forcing his warped and extreme viewpoints on an unwilling public.

There is no evidence that anyone wanted left wing extremism -- zero. Hilary Clinton even said she could not debate the issues with Obama because he didn't stand for anything.

Massachusetts became a referendum on Obama because Pelosi and Reid were essentially urinating all over the Constitution. Even if you support government health care (and the polls say 60% of the public does not) -- passing a law via open bribery and back room deals is just anti-democracy and anti-American.

If there is healthcare reform, it needs to be affordable (meaning LESS cost than the existing system). It also has to be supported by the majority, preferably by a considerable majority.

Even in Congress, it had no support. Most of its "supporters" (including Nelson in Nebraska and Schwarzenegger in California) only supported it when they thought someone else was going to get the bill.

Even within the 40% of the public that "supports" government health care, most do so with the understanding that "the other guy" is going to pay for it.

You do not speak for "everyone", and I dare say your views are pretty extreme. Try showing some respect for other viewpoints -- or else "everyone" should start expecting a lot more embarrassing defeats.

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zanon
admin
January 22, 2010 at 11:13 PM ×

Jesus Willy. If you're going to claim that Brown's victory wasn't a big surprise two weeks ago, then I'm leaving. I'll see Ian at the bar.

You can continue waving whatever political flag you want. I'm really not interested.

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Willy
admin
January 22, 2010 at 11:34 PM ×

@zanon -

It was a surprise for everyone who wasn't listening.

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Anonymous
admin
January 23, 2010 at 12:10 AM ×

So now that politicians secured unlimited stream of funding from every other corporation than banking industry will we get some justice?
Is the Supreme Court decision and Volcker Reform announcement a coincidence?

By the way Macro Man I think this is is the single most classy financial blog one on the net, but I really don't understand your pro prop trading by TBTF bank arguments, this time you are talking your book and you lost your cool.

Are these banks such a retards that they HAVE to pay this enormous bonuses "in your face", when they owe so much money to the taxpayer (Tarp, Talf, MBS buyback, mark-to-fantasy etc.) and possibly never pay it back?
It looks like they know their world is ending and they need to grab as much as possible.

Populism or not populism this people are really sick and bonuses made them crazy.
It's like having a high score at some moronic computer game and bragging about that to your friends when you were in high school. "Hey i made seven point five this year, how about you? Five? Oh, you must try harder next year..."

That's the main motivation for their work, except for Goldman employees who live in a sect so they have to obey the Grand Wizard and nothing more matters, money is just a score card.

The whole world will pay for this feckless behaviour for years... every little kid... for somebody's bonus...

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Anonymous
admin
January 23, 2010 at 1:36 AM ×

@Ian

Treasuries are not a free market. Those prices are controlled by the Fed.

Politics move markets, no matter how distasteful the debates might be

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Mr Banker
admin
January 23, 2010 at 1:37 AM ×

Welcome to the Banana Republic Casino! I am your host, Mr Banker.

Place your Bets! If you win, you in; if you lose, you lose. But in no case are you allowed to bet more chips than you actually have in your possession.

I, on the other hand, will not put any of my own chips at risk. I will borrow chips from my stooges, Geithner and Bernanke. If I win, I pay back the loan and pocket the winnings. If I lose, my stooges will charge the bets to your accounts. You get no say in this at all! Screw you little people. If you run out of money, you can always get a job cleaning my $35,000 toilet.

At some point tonight, you might see an octogenarian about six foot seven inches show up and suggest that I, MR BANKER, should play by the same rules as the rest of you wretched filth.

If this happens, I will whine and cry and bitch and smash glasses and stamp my feet and generally throw the mother of all temper tantrums.

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Anonymous
admin
January 23, 2010 at 2:10 AM ×

Macro Man - your blog is superb, one of the best market blogs out there. You do a great service to traders everywhere, so please keep cool as you read this! Respectfully I agree with much of what Gary says in this debate. The public has turned against what they perceive as 'capitalism', but that is not the system that we have in place any more, it is a very dangerous path that has been trodden down. What we do have is taxayer-insured prop trading. Except for the most risk averse deposit taking institutions all private companies should be allowed to fail. What is this business with investment banks borrowing from the Fed at 0%? Why should they be subsidized by the taxpayer? Goldman Sachs is the best of the subsidized investment banks, but they have even been bestowed further privileges beyond this, such as having an ex-GS man running the Treasury, infiltrating the Fed, aquiring 'bank holding status' during the peak of the crisis when their application was 'fast-tracked'...there is nothing wrong with with record profits and bonuses but provided it has absolutely nothing to do with the taxpayer, and the firms making these profits are borrowing at commercial rates, just as GS did when they wanted Buffet's cash. I admire your courage and honesty here in tackling this subject, but as an outsider (prop trader, ex bank) the view is a lot different. The Fed should be the lender of last resort not the lender of first resort to the selected few.

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Anonymous
admin
January 23, 2010 at 2:31 AM ×

The Sun and the Earth both orbit the center of mass of the pair, which is a point somewhere inside the Sun.

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Charles
admin
January 23, 2010 at 3:07 AM ×

"Banning prop trading and ownership of investment management businesses is not the solution to the problem. Restricting leverage to systemically safe levels is."

MM, that is the core of the problem, Central Bankers, regulators and rating agencies have proven inept at determining what leverage level is systemically safe for a given asset class / financial instrument. The main reason for this is that these leverage limits are buried hard into technical details like de-consolidation criteria, counter party risk add-on, VaR multiples, cross asset class correlations etc..., only understood by a few technical guys whose only wish is to work for an investment bank to show where the loopholes are and join the gravy train. Essentially, regulators and Central Banks play with the ultimate other people's money which is the taxpayer's money.

Alan Greenspan knew this, and counted on the "self interest of organizations" to make sure that the equity layer was sufficient and thus, leverage levels appropriate. He was badly mistaken and recognized it, because he kept a blind eye on agency problems. To show the extent of how he was wrong, even GS, who has a first-class risk management culture (not coincidentally because they were the last to switch from a private partnership structure), would have gone belly up in 2008 without the Government intervention.

So, no, there shouldn't be ANY involvement of public money, actual or contingent, at whatever level of capital structure (equity, mezzanine or senior) for prop trading and market-making activities. As the Federal Reserve refinancing mechanism and the FDIC structure are ultimately public money, banks should get out of this business. That will go a long way to restore sanity in leverage levels.

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Macro Man
admin
January 23, 2010 at 12:20 PM ×

Sigh. So many straw men, so little time. Nowhere have I argued that TBTF banks should be allowed to carry on taxpayer-guaranteed prop trading.

I have argued that banks should be neither TBTF nor government guaranteed. Beyond that, they should be allowed to conduct business as they see fit. Why can they own/invest in mutual funds but not HF or PE? The investment performance of the latter trounce the former, and it's not exactly like asset-farmers are pure as the driven snow, is it....or have we forgotten Janus already?

Prop trading is an activity that allows banks to make use of one its primary intangible assets: information. I am not talking about front-running equity clients, I am talking about legal trading done by a variety of other organizations. Central banks prop trade. Automakers prop trade (Porsche is basically a hedge fund that makes fast cars). Telecoms companies prop trade. It seems a bit odd to ban banks from doing so if they are outside the aegis of public support, which, again, is what I suggest.

Finally, bear in mind that while banks are certain culpable for the financial crisis, they are far from the only ones to blame. The Agencies (both GSE and ratings) are to blame. Insurance companies are to blame. And the public, who bought houses they couldn't afford (and KNEW they couldn't afford) with non-recourse loans that they swiftly stopped servicing are also to blame. If we're going to ban banks from prop trading, shall we also ban the public from buying houses, since they, too have received public support?

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Anonymous
admin
January 23, 2010 at 1:35 PM ×

MM,
The probis it's lot more comfortable for self interest for many involved parties to just take the blame aim at banks.The fact that the line up of twats behind GFC is virtually inclusive of everyone not living in a cave is conveniently overlooked.
Leaverage,leaverage and leaverage is the source of angst ,too much ,too available,too unregulated.Capping that is the first step to financial sanity.If the powers then want to go further and tie ribbons around the activites that merit govt support then go ahead ,but make sure those activities encompass the full line of twatish behaviour and there's lots that have nothing to do with prop trading.

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Greg
admin
January 23, 2010 at 3:04 PM ×

MM - too bad the banks don't make use of the "information" they supposedly have to manage their risk. That would actually have some value.

Also, while you claim not to support TBTF policies -- you haven't said how prop trading could occur within a bank while still allowing deposits to be taxpayer insured. Even if the prop desk / hedge fund was in a bankruptcy remote entity (like the SIVs were) -- there is absolutely no credibility to the idea that the parent company wouldn't be dragged in to the problems of its subsidiary prop desk / HF.

The only way to make the prop desk / HF truly separate from the taxpayer protected bank is to make it actually be a separate entity, preferably a partnership or some legal structure that forces senior management to look after the risk as though it is their own.

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Anonymous
admin
January 23, 2010 at 3:45 PM ×

Investing in hedgefunds and private equity firms had almost nothing to do with the subrime mortgage lending recession that has spilled over and lasted those 3 years. In fact, it through these very avenues that they were able to generate capital during the recession. I mean lets take a look at what caused these banks and firms to go out of business or become troubled. It was not completely investing in hedgfunds or private equity firms.

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Greg
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January 23, 2010 at 3:57 PM ×

the banks suffered massive losses from their proprietary trading of subprime mortgage debt.

Often the subordinated tranches of deals (the riskiest stuff) could not be sold so it had to be kept on the banks books (where it should have been hedged). The banks didn't have proper risk systems to do this hedging, which eventually forced them to use accounting tricks like SIVs and bank operated hedge funds to create the illusion that the risk was no longer on the bank's books even though it was.

The regulators simply don't have the insider knowledge needed to evaluate and understand these risks. The shareholders have far less information, and most have less expertise.

Only the senior management inside the bank has (theoretically) both the access and the expertise to understand the risk.

That is why a partnership (or whatever structure where senior management keeps tabs on each other out of self interest) is the only way to avoid regular crisis and taxpayer bailouts

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Anonymous
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January 23, 2010 at 5:30 PM ×

Stop the whining you poor prop traders.

Every reasonable human being that still has a conscience should admit that all the criminal organizations (aka banks) are only still around cause ordinary hard working people bailed them out with their money. And much to my dismay, we do not publicly (and physically) punish such criminals any more these days because obviously this is the only way they would learn their lesson.

So, honestly, I don't give a crap if it was the fault of the prop trading branch, the underwriting guys or whoever. You guys in general do NOT REMOTELY deserve bonuses the size you actually get, cause there is not a fraction of this money created in REAL values by your actions. Or as Volcker put it correctly: the only meaningful innovation by the banks was the ATM.

So, I am totally favouring Glass Steagall II and then you guys can sink your ship as you see fit...

Best regards

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Anonymous
admin
January 23, 2010 at 5:54 PM ×

Banks and airlines have a lot in common:

-Both have massive overcapacity
-Both cannot function without massive taxpayer subsidies
-Both FOCUS on all sorts of deputy police work (TSA assistance or credit bureau assistance) while ignoring their actual business
-Both regularly display disregard if not open hostility toward their customers

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Macro Man
admin
January 23, 2010 at 6:15 PM ×

Given the progressive nature of the US income tax system, the "ordinary, hard-working" American has contributed very little to the bailouts. Certainly less than the overconsumption and irresponsible real estate choices of the same "hard-working, ordinary" American contributed to the crisis.

While banks are also culpable, uninformed rants of "they're all a buncha crooks!!!" really belong on another site. Feel free to go there now.

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Greg
admin
January 23, 2010 at 6:42 PM ×

MM - given the fiscal structure of the US government, it would be a lot more honest to say that neither the "poor" nor the "rich" are paying to bail out banks

Our children will get the bill. Its all being paid for with debt. Trillions in debt, and neither political party has a credible plan to run even balanced spending, much less a surplus needed to pay the debt back.

So lets be honest here. We are sending the bill for our mistakes to our children and their children.

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Anonymous
admin
January 23, 2010 at 8:18 PM ×

Greg - you forgot to mention that the bankers get paid (indirectly) an underwriting fee for issuing the debt / sticking our kids with the bill... the primary dealers and the banks are one and the same

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zanon
admin
January 24, 2010 at 6:36 AM ×

MM - What a load of BS. The highest level of income taxes kick in at about the level of doctors and engineers -- people who actually do something useful and productive for a living.

There is something deeply broken with a financial system that does not care whether or not the loans it makes get paid back. There is something deeply broken with a financial system where prop trading is backed by public money. There is something deeply wrong with an individual who cannot see this. Bankers are a product of their environment. The environment has to change.

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Anonymous
admin
January 24, 2010 at 7:31 AM ×

"As an aside, I've not read very much at all about the Supreme Court decision allowing corporatations, unions, etc to go crazy in donating to politicians' campaigns."

That's not right. The decision allows corportations to spend their money advocating candidates. The ban on donations TO candidates still exists (maybe a larger distinction in theory than in practice).

"And even if it was true, central bankers have insulated bad banks from all market pressure."

How true. Great observation.

"It sounds bad in 20/20 hindsight, but you can't prove anything beyond a reasonable doubt (i.e. in a court of law)."

That ("beyond a reasonable doubt") is for criminal convictions. Most civil cases only require a "preponderance of evidence." See http://en.wikipedia.org/wiki/Burden_of_proof#Standards_for_conviction

"The Sun and the Earth both orbit the center of mass of the pair, which is a point somewhere inside the Sun."

Good one. :) My favorite question to ask applicants was "how long does it take for the earth to rotate 360 degrees about it's own axis?" I expected people "good with numbers" to be able to compute the answer in their heads (to an accuracy of five seconds). Of course some people familiar with astronomy already knew the answer. :)


I don't know how the "financial reform" gets resolved, but I do know a lot of people at small trading firms who are quite pissed off (rightly so, in my opinion) about having to compete with firms who have access to government guaranteed deposits. Borrowing at the Fed Funds rate to fund a "heads, I win - tails, the taxpayer loses" business model just isn't going to fly any more.

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Rossco
admin
January 24, 2010 at 9:20 AM ×

Sort of agree we haven't seen the big one yet...with the short end not exactly going banzai.

I am wondering whether margin calls this week on the back of the significant uptick in vols (rather than mtm losses) creates quite a need for $$$$$.

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Anonymous
admin
January 24, 2010 at 12:32 PM ×

It sure feels like W but some how I have a feeling the Bernanke Put is going to come to the rescue. What do you guys think?

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haruspex
admin
January 24, 2010 at 3:23 PM ×

@ Gary:
several interesting posts. Your experiences remind me of mine, in a similarly large US bank.

@ Macro Man:
I am confused by your point of not guaranteeing banks. Surely we know that the basic banking functions (deposit taking, payment systems and similar) are fundamental to the running of the economy, and hence must be guaranteed?
That is why we new a new, better Glass Steagall.
We cannot afford to be 20 minutes away from ATM machines being switched off (see UK last year) ever again, but on the other hand we do want financial institutions that take risks, punt, and when necessary fail: so we need to keep them separate.

Of course, just separation is not enough. Several other measures are needed (e.g. a serious revision of so called mark-to-market rules) but won't bore you here with that.

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Macro Man
admin
January 24, 2010 at 5:25 PM ×

@harupsex, in a lower leverage world deposits can be guaranteed the old fashioned way, via the FDIC insurance fund, whereas other liabilities need not be guaranteed given that systemic risk would not be as widespread in a 12-15x max leverage world.

I have zero problems with a new Glass Steagall. But if that's what they want, then that's what they should enact!

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Rita
admin
January 24, 2010 at 9:33 PM ×

Separating through Glass Steagall or any other forms that reduces systemic risk is not the problem, if it could be done in all of the G20 countries. This will be fair to any large size bank that wants to remain global.

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