Sunday, February 28, 2010

The Greek Debt Debacle: Likely Winners and Losers

I think this matter of banks having facilitated Greece's hiding of the magnitude of its debt is going to get a lot more interesting before its all over. Here's an update on the story from the NY Times: "Banks Bet Greece Defaults on Debt They Helped Hide." Here's the short story:

  • A number of European banks and America's own Goldman Sachs engineered a number of complex currency swap transactions that allowed Greece to understate its debt.
  • Since these banks had inside knowledge that Greece's financial position was much less secure than it appeared, being good opportunists, the went out and bought credit default swaps (insurance against default) on Greece's debt. So, they made big fees setting up the scheme, and they stand to benefit if the scheme falls apart.
  • Who did they buy the credit default swaps from; i.e., who was the unwitting sucker to take the bet? Probably multiple issuers, but it looks like the brain trusts at AIG were among them, which means that the American taxpayer would be on the hook in the case of Greece's default, given that the U.S. now owns 80% of AIG.
  • So, if Greece gets closer to default, this means that the U.S. either bails out Greece to avoid losses at AIG, or it just steps up and bails out AIG yet again. Once again, the financial industry wins, and the taxpayers lose.
From a translation of an investigative piece from the German newspaper Frankfurter Allgemeine Zeitung:

London investment bankers name AIG as a further CDS-seller. That company had to be nationalized during the financial crisis due to its having written insolvency insurance on American mortgages. This debt-load would have led to the collapse of the world’s biggest insurer. Prior to the financial crisis AIG is said to have widely held State credit-risk. If yet-larger insurance positions on Greece exist, then the American government would have a strong interest in preventing that country’s insolvency.

The Flawed Compensation System in Investment Banking

Here's a good article from the prolific Edward Harrison that explains the differences between conventional corporations (including commercial banks) and the big Wall Street firms relative to how people are compensated and who's really calling the shots on risky decisions. In the Wall Street firms (Goldman Sachs, and the now-departed Lehman and Bear Stearns), the top execs are often clueless about the risks their firms are taking (which is a major problem, of course), and you have much lower level people pulling off hugely risky deals. If they win, their payouts are huge. If they fail, they get fired, but just move down the street to another firm. This is why we can't give the same protections to Wall Street that we give to commercial banks. They should be allowed to take risks, but not with government backing. That's what the proposed Volcker rules are all about.

From Mr. Harrison's article:

Corporate hierarchies

In a normal corporate environment, there is a strict hierarchy in which those at the top earn more than those at the bottom. In order to rise to the top (and earn the salary and huge bonus – I might add), one needs to be considered successful. And that means putting in years of effort for which one receives performance reviews.

If you do well on these reviews, you might even receive accolades, awards and so on – the point being you are a rising star with talent. So you get promoted. “The way you’re going, you might even rise to CEO one day!” That’s the kind of praise you might hear. So the whole hierarchical apparatus is designed to align high achievement with other external signs of success: good evaluations, promotions, more money, more responsibility, more underlings, larger budgets, awards, and accolades and so on. All you need to do is look at an org chart and you get a pretty good sense of who’s supposed to be the stars. And by the way, this is how it works in commercial banking as well.

Investment banking hierarchies

But, that’s not how it works in investment banking at all. When one deal or a series of trades can mean billions in profit, even a relatively junior person can have influence on the bottom line far beyond what her title suggests. This is certainly true in the advisory business, but it is even more true in trading – especially proprietary trading, a major reason that proprietary trading is inherently risky and would be restricted under the Volcker Rule. By the way, this is also a major reason that investment banks that are public companies and not partnerships are risky companies with notoriously poor managers.

A slovenly 32-year old junior trader with terrible social skills, zero management ability and no one reporting to him can make millions of dollars a year. He’s the guy you read about in the newspaper making three times the CEO’s salary. He’s the guy that all the other firms are trying to poach. And he’s the guy that used to be referred to admiringly as a “big swinging dick.” You don’t see that at Acme Incorporated. That’s what I mean when I say it’s all about the money. You learn very quickly in investment banking that status is not all about the titles, it’s more about the money.

Read any account from investment banking like Predator’s Ball or Liar’s Poker you will quickly notice that even the higher level guys are driven to earn a lot of money, not only for the money itself but for what that money says about their status and value relative to their peers.

You can read his full article on Seeking Alpha here.

Conservatives targeting their fringe

On the heels of the Scott Brown victory in Massachusetts, it looks like Republicans are finally learning that they don't need to kowtow to the far right. I wrote about the need for this back in October.

From the Politico article:

After months of struggling to harness the energy of newly engaged tea party activists, the conservative establishment — with critical midterm congressional elections on the horizon — is taking aim for the first time at the movement’s extremist elements.

The move has been cast by some conservatives as a modern version of the marginalization of the far-right, anti-communist John Birch Society during the reorganization of the conservative movement spearheaded by William F. Buckley Jr. in the 1960s and 1970s.

“A similar effort will be required today of conservative political and intellectual leaders,” former Bush speechwriter Michael Gerson wrote in his column in The Washington Post. “It will not be easy. Sometimes it takes courage to stand before a large crowd and proclaim that two plus two equals four.”

Read the full article on Politico here.