Latest check-up on GGGB10YR reveals further deterioration - the yield is now 7.32%, which is 17bps wider than yesterday all-time wide. The spread to Bunds is now a whopping 424 bps. ZeroHedge reported yesterday that 450 bps is about as much as Greece will be able to stand. At this rate of deterioration, we will reach that point very soon, possibly by the end of the day or by Monday at the latest.
A European "Lehman weekend"?
Thursday, April 8, 2010
Monday, April 5, 2010
So... what about those jail terms for bankers?
Matt Taibbi does another takedown of the banksterscamster culture we had (have?) in this country. Jefferson County has made headlines before, of course - so how come none of the guys from JP Morgan that were involved in these blatant violations of the Sherman Act and federal and state anti-bribery statutes have been even indicted yet?
Does size matter?
Among the central topics of debate on the FinReg proposals is whether size matters.
Some (or many) think that downsizing TBTF is absolutely essential to the new legislation. The Volker rule which would limit activity is but a step in that direction, albeit an important step. Another, more decisive step would also limit the amounts of deposits that any banking instutution can keep and the amount of aggregate assets that it can have (on an off the balance sheet).
Others, like notably Paul Krugman in today's column, believe that size is not an issue. The basic argument here is that even if the financial institutions are small, in a pinch they'll have to be bailed-out anyway and a run on big banks is neither more nor less likely to happen than a run on small banks. In fact, both the Great Depression (and many bank panics that preceded it) as well as the more recent S&L crisis featured such runs on rather small financial institutions. And, as Krugman points out, it was very likely a mistake for the government to let the banks fail willy nilly during the depression.
So where do I come down on this? The former view - and here is why.
Krugman and others of the same view a missing the point and the problem of bailouts. It may not, indeed, necessarily be the case that we would let a bunch of small banks and financial firms fail in the next financial crisis without trying to prop up the system in some way or another - putting aside whether this is a good thing to do or not for a moment, the politics of the moment usually overwhelm sound thinking in these types of situations.
However, there are key advantages to having a world composed of small instututions from regulatory point of view at the time of a crisis:
1. When financial instututions are less inter-connected and have fewer tentacles, it is easier for regulators to operate them in receivership without much help from their management. In many cases, this should obviate the need for one of the most puke-inducing part of the AIG bailout where the chumps who caused all the trouble were nevertheless kept on board because they were the only ones who could help untangle the mess they created.
2. The most egregious players could be simply let go of, and made an example of. This did not happen in the last crisis - because the most egregious players were also some of the biggest. Lehman WAS made into a test-case, but that did not exacly ended well.
3. You could even experiment with different resolution regimes and test in real time which one is working better. It is highly unlikely that the whole system will be brought to its knees in a matter of days - what we'd probably have is an accelerating wave of failures that would be spaced out over the course of several months. This was the case in the current crisis - with Bear Stearns being the canary in the goldmine. But because Lehman and other systemically important players managed to put off the inevitable by a few more months through creative accounting, the regulators were basically caught flat footed both by the Bear Stearns failure and by the avalanche of near-failures that followed 6 months later. Imagine now, instead, that we'd have a slow at first but gradually building wave of small instututions going under: regulators would have a much better chance of developing a coherent responce by the time the crisis peaked in the Fall of '08.
Some (or many) think that downsizing TBTF is absolutely essential to the new legislation. The Volker rule which would limit activity is but a step in that direction, albeit an important step. Another, more decisive step would also limit the amounts of deposits that any banking instutution can keep and the amount of aggregate assets that it can have (on an off the balance sheet).
Others, like notably Paul Krugman in today's column, believe that size is not an issue. The basic argument here is that even if the financial institutions are small, in a pinch they'll have to be bailed-out anyway and a run on big banks is neither more nor less likely to happen than a run on small banks. In fact, both the Great Depression (and many bank panics that preceded it) as well as the more recent S&L crisis featured such runs on rather small financial institutions. And, as Krugman points out, it was very likely a mistake for the government to let the banks fail willy nilly during the depression.
So where do I come down on this? The former view - and here is why.
Krugman and others of the same view a missing the point and the problem of bailouts. It may not, indeed, necessarily be the case that we would let a bunch of small banks and financial firms fail in the next financial crisis without trying to prop up the system in some way or another - putting aside whether this is a good thing to do or not for a moment, the politics of the moment usually overwhelm sound thinking in these types of situations.
However, there are key advantages to having a world composed of small instututions from regulatory point of view at the time of a crisis:
1. When financial instututions are less inter-connected and have fewer tentacles, it is easier for regulators to operate them in receivership without much help from their management. In many cases, this should obviate the need for one of the most puke-inducing part of the AIG bailout where the chumps who caused all the trouble were nevertheless kept on board because they were the only ones who could help untangle the mess they created.
2. The most egregious players could be simply let go of, and made an example of. This did not happen in the last crisis - because the most egregious players were also some of the biggest. Lehman WAS made into a test-case, but that did not exacly ended well.
3. You could even experiment with different resolution regimes and test in real time which one is working better. It is highly unlikely that the whole system will be brought to its knees in a matter of days - what we'd probably have is an accelerating wave of failures that would be spaced out over the course of several months. This was the case in the current crisis - with Bear Stearns being the canary in the goldmine. But because Lehman and other systemically important players managed to put off the inevitable by a few more months through creative accounting, the regulators were basically caught flat footed both by the Bear Stearns failure and by the avalanche of near-failures that followed 6 months later. Imagine now, instead, that we'd have a slow at first but gradually building wave of small instututions going under: regulators would have a much better chance of developing a coherent responce by the time the crisis peaked in the Fall of '08.
Friday, February 26, 2010
Some thoughts on building a better law firm compensation system
The biglaw model has gone through quite an upheaval in the past year and a half. Firm dissolutions, mass layoffs (including the previously sacrosant first-years by Latham Watkins), stealth layoffs, salary freezes and finally salary restructuring away from the lockstep model that is proving to be unsustainable for all but the best-managed shops, especially if you try to keep up with the Cravath-Sullivan-et. al. salary scale.
So what's to be done? Some of the latest moves have been away from lockstep compensation of associates and towards performance-based systems. I won't bother with citing specific examples (which are cited and discussed ad nauseum on Abovethelaw), but the attempts to deep-six the lockstep have ranged from merely making bonuses tied to performance to tying associate advancement through three or four tiers of salary levels tied to performance rather than seniority. The idea, ostensibly, is to promote competition and to reward talent.
On the partner side, compensation systems had more variety before, and I don't think that general picture has changed. Many firms reward their rainmakers with much higher share in profits. At the same time, there are some very prominent examples of firms that are lock-step top to bottom, with partners in the same class getting the same salary, irrespective of how many clients they bring, irrespective of practice area and irrespective even of where in the world they are located.
So which is better? One the one hand, lock-step compensation undoubtedly fosters a more transparent and cooperative work-environment, where associates are not trying to dig each other's grave, hoard work or to otherwise screw peers, and where partners do not wage turf wars on a constant basis (e.g., which litigation specialist gets the next referral from M&A or who gets that superstar associate under their wing) or reward those who have the brownest noses. On the other hand, partners in such places lack incentive to bring new business, and associates - especially those who don't plan to stick around forever and are therefore not particularly motivated by the partnership carrot - have no motivation to try harder.
I have a solution to propose, aiming to combine the virtues of both approaches:
1. Separate firms into fairly independent groups by practice area, with sizes generally of 5-7 partners and 15-20 associates. Cap leverage ratio at, say, 4.
2. Lock-step salaries of associates across the board, and lock-step bonuses by practice group.
3. Distribute a percentage of partners profits across the board (e.g., 50%) in lock-step by seniority and the remainer ("Profit Remainder") based on the relative contribution of practice groups to the overall bottom line (adjusted for the group's size). Within a practice group, this remainder would be distributed among the group's partners by seniority.
4. Encourage cross-practice group referrals by additionally allocating 5-10% of the revenues generated through referral to the practice group where the referral originates. This would factor in the calculation of the Profit Remainder.
5. Money-losing practices get zero bonuses for associates and zero Profit Remainder for Partners.
6. Recruit law students on a firm-wide basis, and initially assing associates based on expressed preference after the summer program. Associates would be asked to express 1st, 2nd and 3rd preference. In allocation, observe the caps to leverage ratio for each practice group. Associates are initially allocated to their first preferred group, but if too many want to get into the same practice group, they would be allocated by lottery, with those who don't get in then assigned to their 2nd preferred group.
7. Mandate rotations after a 1-1.5 years to another practice group. Allocation is done as in step 5. After completing rotation, associates can come back to original group or stay in the second group, based solely on their choice. If their choice pushes the leverage ratio of any one group above the limit, that group gets fewer rookies.
8. Practice groups can recruit associates laterally at their discretion, so long as leverage ratio caps are observed.
The core idea in the above is that collaboration and transparency is preserved within each practice, but competition is fostered among different practices.
So what's to be done? Some of the latest moves have been away from lockstep compensation of associates and towards performance-based systems. I won't bother with citing specific examples (which are cited and discussed ad nauseum on Abovethelaw), but the attempts to deep-six the lockstep have ranged from merely making bonuses tied to performance to tying associate advancement through three or four tiers of salary levels tied to performance rather than seniority. The idea, ostensibly, is to promote competition and to reward talent.
On the partner side, compensation systems had more variety before, and I don't think that general picture has changed. Many firms reward their rainmakers with much higher share in profits. At the same time, there are some very prominent examples of firms that are lock-step top to bottom, with partners in the same class getting the same salary, irrespective of how many clients they bring, irrespective of practice area and irrespective even of where in the world they are located.
So which is better? One the one hand, lock-step compensation undoubtedly fosters a more transparent and cooperative work-environment, where associates are not trying to dig each other's grave, hoard work or to otherwise screw peers, and where partners do not wage turf wars on a constant basis (e.g., which litigation specialist gets the next referral from M&A or who gets that superstar associate under their wing) or reward those who have the brownest noses. On the other hand, partners in such places lack incentive to bring new business, and associates - especially those who don't plan to stick around forever and are therefore not particularly motivated by the partnership carrot - have no motivation to try harder.
I have a solution to propose, aiming to combine the virtues of both approaches:
1. Separate firms into fairly independent groups by practice area, with sizes generally of 5-7 partners and 15-20 associates. Cap leverage ratio at, say, 4.
2. Lock-step salaries of associates across the board, and lock-step bonuses by practice group.
3. Distribute a percentage of partners profits across the board (e.g., 50%) in lock-step by seniority and the remainer ("Profit Remainder") based on the relative contribution of practice groups to the overall bottom line (adjusted for the group's size). Within a practice group, this remainder would be distributed among the group's partners by seniority.
4. Encourage cross-practice group referrals by additionally allocating 5-10% of the revenues generated through referral to the practice group where the referral originates. This would factor in the calculation of the Profit Remainder.
5. Money-losing practices get zero bonuses for associates and zero Profit Remainder for Partners.
6. Recruit law students on a firm-wide basis, and initially assing associates based on expressed preference after the summer program. Associates would be asked to express 1st, 2nd and 3rd preference. In allocation, observe the caps to leverage ratio for each practice group. Associates are initially allocated to their first preferred group, but if too many want to get into the same practice group, they would be allocated by lottery, with those who don't get in then assigned to their 2nd preferred group.
7. Mandate rotations after a 1-1.5 years to another practice group. Allocation is done as in step 5. After completing rotation, associates can come back to original group or stay in the second group, based solely on their choice. If their choice pushes the leverage ratio of any one group above the limit, that group gets fewer rookies.
8. Practice groups can recruit associates laterally at their discretion, so long as leverage ratio caps are observed.
The core idea in the above is that collaboration and transparency is preserved within each practice, but competition is fostered among different practices.
Wednesday, February 24, 2010
Euro Carry Trade???
This is making no sense to me at all. Bloomberg writes:
At a very elementary level, there are at least two reasons why a currency might experience a decline. One is a carry trade, where short-term borrowing in one currency is used to finance purchases of another, so that instututions and individuals sell the funding currency (driving down its price) and buy another.
The other is when weakness in the economy substantially decreases government revenue, necessitating increasing currency sales (or money printing) by the government itself.
If Euro continues to suffer it will not be because of reason #1.
"The euro will become a favorite funding currency for carry trades as Greece’s crisis weighs on regional interest rates, according to Deutsche Bank AG."Huh??? I thought that interest rates go UP if the bond prices go DOWN, as is currently happening to Greece. The safest of Euro bonds (German Bunds) are still yielding slightly above comparable tenor US Treasuries and far above the level of Japanese bonds. Regardless of whether or not Greece defaults, this situation is unlikely to change in a direction that would enable a Euro carry-trade.
At a very elementary level, there are at least two reasons why a currency might experience a decline. One is a carry trade, where short-term borrowing in one currency is used to finance purchases of another, so that instututions and individuals sell the funding currency (driving down its price) and buy another.
The other is when weakness in the economy substantially decreases government revenue, necessitating increasing currency sales (or money printing) by the government itself.
If Euro continues to suffer it will not be because of reason #1.
Wednesday, December 9, 2009
The Gold Bug decease
There is a lot of garbage on the internets about gold these days. Head over to ZeroHedge and, on a daily basis, the site has at least one post on the price of gold - and each post will generate well over a hundred responses from a dedicated army of gold bugs. Bloomberg has opinion pieces on the subject - generally more balanced, but with both perspectives on the subject. Financial analysts, hedgies and CNBC garbage cans all talk about the falling dollar and in the next breath will inevitably allude to gold one way or another. So I thought I'd jump on the bandwagon and offer a few words of wisdom: gold bugs are idiots.
1. Gold as inflation hedge. As an empirical matter, gold used to offer passable protection from inflation, but really got messed up in the later part of the 20th century as the gold standard went by the way of the dodo. Here is a chart, shamelessly stolen, from here.
Obviously, if gold were a perfect hedge, real price would be flat. It's not. Gold bugs will inevitably argue that there is a problem with CPI data sice it excludes the volatile energy and food prices (and the beginning of the 1977-1981 run-up in gold price correlates highly with the oil crisis back then, as does the run-up of late 2000s). That's all well and good of course, but as a consumer I don't live to buy oil - I only consume it in a form of gas, and it's not really all that much when you compare it to items like the rent or the cost of a car itself. Surely, from a consumer's perspective, no oil bubble justifies a runup in price of an "inflation hedge" so steep - and subsequent corrections bear that out.
2. Gold as an investment asset. Well, it's really an odd one. Empirically again, it's performance is not bad - but you really have to time it right to not get completely screwed over. And of course, there is no dividend stream or any income as such at all to compare gold to something like bonds or stocks. So it's hard to find a fundamental justification for the price of gold in this sense.
3. Gold as currency. This is a good one. Last time I checked, gold coins are not an accepted form of payment in supermarkets, gas stations, restaurants or event bordellos. Dollars - paper ones, or electronic ones - are. There are other currencies too, but none of them are gold, or are even convertible into gold.
Gold bugs say that fiat currencies will collapse (because there is no check on the governments ability to print) and since gold can't be printed and its supply is rather steady, it's the only real currency out there, to which when the proverbial shit hits the fan, everyone will inevitably revert. This ties into a theory of gold being a good financial armageddon protection (given that there has been few such events during modernity, this is a claim that is hard to confirm empirically). Let's examine this one a bit more closely.
There is no argument that gold used to be a currency. This has been true for much longer than any of the modern fiat currencies have been in existence, and, in fact, has been true during the bulk of western civilization's existence. But ultimately any currency is valuable only if many people believe that it's valuable. In other words, for a currency to function, people must believe in the system. Gold bugs expessly reject such belief in the current system, because... well, you know, the government is bad, helicopter Ben can print money at a push of a button and Timmy G and BO are in the pocket of Wallstreet.
But what eludes them is that if the current monetary system indeed collapses, there is absolutely no guarantee that the one that immediately preceded it will step up to take its place. Put another way, if the financial and economic armageddon does take place, why would one think that gold will suddenly be accepted as payment for bread? More fundamentally, what makes anyone think that there will be any bread to buy? There is actually recent empirical evidence to the contrary: in none of the countries that have undergone through massive currency devaluation and hyperinflation, e.g., the former Soviet bloc in the early 1990s, nobody even tried (or thought of trying) using precious metals as legal tender. And oh yes, there really was very little bread to actually buy. It sucked -- and gold reserves were of absolutely no help. What helped was having USD, which began to circulate in large quantities and in which anything that was of any importance was priced and measured. If dollars were unavailable, people would probably resort straight to barter. Thus, when shit hits the fan, that gold bar might buy you shelter for life, a loaf of bread for a day or anything in between, above or below - it'll take a while, if ever, before the bread/gold exchange rate settles down in the absense of actual currency.
5. Simple math/conclusion. There is little to no fundamental demand for gold, as stated above. At present, it's price is therefore a factor of (1) the growth in money supply relative to the growth in the supply of gold and (2) how many people belive that gold has any value whatsoever. Factor (2) is what fuels speculative bubbles in gold. A belief that the price of gold will always increase requires a belief that either the government will keep printing money like crazy forever (demonstrably false) or that the number of people who believe that gold has value will increase. The influence of factor (2) is not to be underestimated - and this really makes gold worse than anything else out there: if no one has faith in gold, it will become completely worthless. It's true that people could decide that the dollars aren't worth the paper they are printed on anymore. But, objectively, how much more likely is that to happen than the people deciding that gold is of no use or value to anybody - which is true, by the way - and you can't even wipe your ass with it?
If people are looking to invest in something that has constrained supply and therefore not subject to Fed's manipulations and something you can "store", they could look to precious metals with industrial uses, such as platinum or palladium, or, better yet, land/real estate. The latter, by the way, has a pretty fundamental value: so long as there are people, they will need a place to live. And if there are no people... well, who cares about capital preservation at that point? Of course, just as is the case with gold, real estate has proven to be succeptible to the problem of belief: when too many people start thinking that it will incraese in value, bubbles form, and one might get screwed. Still, one won't get screwed nearly as much as if one bought gold at $800+ per ounce in 1980. That was one horrible "store of value."
1. Gold as inflation hedge. As an empirical matter, gold used to offer passable protection from inflation, but really got messed up in the later part of the 20th century as the gold standard went by the way of the dodo. Here is a chart, shamelessly stolen, from here.
Obviously, if gold were a perfect hedge, real price would be flat. It's not. Gold bugs will inevitably argue that there is a problem with CPI data sice it excludes the volatile energy and food prices (and the beginning of the 1977-1981 run-up in gold price correlates highly with the oil crisis back then, as does the run-up of late 2000s). That's all well and good of course, but as a consumer I don't live to buy oil - I only consume it in a form of gas, and it's not really all that much when you compare it to items like the rent or the cost of a car itself. Surely, from a consumer's perspective, no oil bubble justifies a runup in price of an "inflation hedge" so steep - and subsequent corrections bear that out.
2. Gold as an investment asset. Well, it's really an odd one. Empirically again, it's performance is not bad - but you really have to time it right to not get completely screwed over. And of course, there is no dividend stream or any income as such at all to compare gold to something like bonds or stocks. So it's hard to find a fundamental justification for the price of gold in this sense.
3. Gold as currency. This is a good one. Last time I checked, gold coins are not an accepted form of payment in supermarkets, gas stations, restaurants or event bordellos. Dollars - paper ones, or electronic ones - are. There are other currencies too, but none of them are gold, or are even convertible into gold.
Gold bugs say that fiat currencies will collapse (because there is no check on the governments ability to print) and since gold can't be printed and its supply is rather steady, it's the only real currency out there, to which when the proverbial shit hits the fan, everyone will inevitably revert. This ties into a theory of gold being a good financial armageddon protection (given that there has been few such events during modernity, this is a claim that is hard to confirm empirically). Let's examine this one a bit more closely.
There is no argument that gold used to be a currency. This has been true for much longer than any of the modern fiat currencies have been in existence, and, in fact, has been true during the bulk of western civilization's existence. But ultimately any currency is valuable only if many people believe that it's valuable. In other words, for a currency to function, people must believe in the system. Gold bugs expessly reject such belief in the current system, because... well, you know, the government is bad, helicopter Ben can print money at a push of a button and Timmy G and BO are in the pocket of Wallstreet.
But what eludes them is that if the current monetary system indeed collapses, there is absolutely no guarantee that the one that immediately preceded it will step up to take its place. Put another way, if the financial and economic armageddon does take place, why would one think that gold will suddenly be accepted as payment for bread? More fundamentally, what makes anyone think that there will be any bread to buy? There is actually recent empirical evidence to the contrary: in none of the countries that have undergone through massive currency devaluation and hyperinflation, e.g., the former Soviet bloc in the early 1990s, nobody even tried (or thought of trying) using precious metals as legal tender. And oh yes, there really was very little bread to actually buy. It sucked -- and gold reserves were of absolutely no help. What helped was having USD, which began to circulate in large quantities and in which anything that was of any importance was priced and measured. If dollars were unavailable, people would probably resort straight to barter. Thus, when shit hits the fan, that gold bar might buy you shelter for life, a loaf of bread for a day or anything in between, above or below - it'll take a while, if ever, before the bread/gold exchange rate settles down in the absense of actual currency.
5. Simple math/conclusion. There is little to no fundamental demand for gold, as stated above. At present, it's price is therefore a factor of (1) the growth in money supply relative to the growth in the supply of gold and (2) how many people belive that gold has any value whatsoever. Factor (2) is what fuels speculative bubbles in gold. A belief that the price of gold will always increase requires a belief that either the government will keep printing money like crazy forever (demonstrably false) or that the number of people who believe that gold has value will increase. The influence of factor (2) is not to be underestimated - and this really makes gold worse than anything else out there: if no one has faith in gold, it will become completely worthless. It's true that people could decide that the dollars aren't worth the paper they are printed on anymore. But, objectively, how much more likely is that to happen than the people deciding that gold is of no use or value to anybody - which is true, by the way - and you can't even wipe your ass with it?
If people are looking to invest in something that has constrained supply and therefore not subject to Fed's manipulations and something you can "store", they could look to precious metals with industrial uses, such as platinum or palladium, or, better yet, land/real estate. The latter, by the way, has a pretty fundamental value: so long as there are people, they will need a place to live. And if there are no people... well, who cares about capital preservation at that point? Of course, just as is the case with gold, real estate has proven to be succeptible to the problem of belief: when too many people start thinking that it will incraese in value, bubbles form, and one might get screwed. Still, one won't get screwed nearly as much as if one bought gold at $800+ per ounce in 1980. That was one horrible "store of value."
Tuesday, December 1, 2009
BoJ to provide emergency loans to banks
From Bloomberg:
The participant banks can be happy though - here is another way to make a lot of money through very little effort with such cheap 3-months financing. All you need is to find a higher yielding asset that qualifies as collateral for BoJ and bingo! There are still many, many sovereign nations whose 3-months debt yields more than that. Traders would need to try really, really hard to loose any money these days....
When is the madness going to stop? Why to ALL efforts to boost the economy are so focused on monetary stimilus these days - which first and foremost result in banks making more money.
The Bank of Japan said it will provide short-term loans to commercial banks amid pressure from Prime Minister Yukio Hatoyama’s administration to address falling prices and the yen’s surge to a 14-year high.Thus, BoJ's key overnight rate just became also the 3-month rate. At first blush, it's not totally apparent whether this will take the yen down a few notches as the Japanese exporters desperately need it to. The most direct way to achieve the desired result would be for BoJ to boost its QE program, as many others have observed. Today's move may give some boost to the Yen carry trade, but, at least as of today, not so much against the dollar: at quick check, 3-months T-bills are still yielding barely above zero at only 4 bps. To make the essentially riskless trade, an institution could borrow from BoJ at the advertised 0.1% and use the proceeds to buy the equivalent duration T-bills. At today's prices, however, such a trade is a still a losing one (to make any money at all, the 3-months treasury yields would need to be above 0.1%).
The participant banks can be happy though - here is another way to make a lot of money through very little effort with such cheap 3-months financing. All you need is to find a higher yielding asset that qualifies as collateral for BoJ and bingo! There are still many, many sovereign nations whose 3-months debt yields more than that. Traders would need to try really, really hard to loose any money these days....
When is the madness going to stop? Why to ALL efforts to boost the economy are so focused on monetary stimilus these days - which first and foremost result in banks making more money.
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