Banking

James Mackintosh

Nouriel Roubini built his reputation, and that of his Roubini Global Economics consultancy (RGE), on his gloomy, but accurate, predictions of financial doom. He isn’t always right though; and the decision by RGE to publish a call for a military overthrow of the democratic Brazilian government is clearly a mistake.

Ricardo Amaral, a Brazilian economist, pulls no punches in an article on the RGE web site (EDIT: RGE has taken the post down. Here’s the Google cache of the article):

I am suggesting that the military should seize power again in Brazil through a coup d ‘état, because we all know that this massive crime problem that is devastating the Brazilian population can’t be solved under a democratic system of government, and because of the actions that have to be taken to bring peace to all neighborhoods in Brazil. It is time for a benevolent military dictator to take power in Brazil and get the job done.

Mr Amaral even recommends General Augusto Heleno Ribeiro Pereira, commander of the UN Stabilisation Mission in Haiti, as a possible candidate.

This comes after hagiographies of the last three “benevolent dictators” of Brazil, who he credits with laying the groundwork for Brazil’s economic success.

Under the dictatorship of a civilian politician, and later under the dictatorship of the military important economic changes were adopted and implemented in Brazil that planted the seeds for long-term Brazilian economic prosperity.

So who is Mr Amaral? It turns out he’s a direct descendant of José Bonifácio de Andrada e Silva, Brazil’s “patriarch of independence” – and Mr Amaral’s first example of a benevolent dictator, although technically he was minister under the then Prince Regent. Mr Amaral wrote a book about him: “Jose Bonifacio de Andrada e Silva – The Greatest Man in Brazilian History”.

Would Mr Amaral take a post in a new military government? No idea. But here’s what he says in his biography:

Mr. Amaral is a member of the two most politically influential families in Brazilian history the “Andrada Family” and the “Souza Queiroz” – The “Andrada Dynasty” in Brazil is still alive and well, and in the last 200 years we had more than 50 members of our family who were Prime Ministers, Finance Ministers, Secretary of various branches of government, state Governors, Mayors, Attorney General, various Ambassadors, and so on.

It is worth highlighting that RGE explicitly distances himself from anything written for its Economonitor web site, which aims to reflect different views; a sort of online op-ed page. From personal experience I can say it is often hard to convince readers that opinions expressed on the FT op-ed page are not necessarily the opinions of the newspaper; it will be harder still for an economic consultancy to pull that off. One has to wonder how welcome Mr Roubini will be in Brasilia from now on.

James Mackintosh

Thought the short sellers were up to no good? You’re not alone, at least when it comes to short-selling collateralised debt obligations (CDOs), one of the acronyms behind the financial crisis. And now you can sing along to the tune. US hedge fund Magnetar, according to an investigation by ProPublica, took a leading role in pumping up subprime debt by helping create the CDOs it then went on to short. Even better than the article, which should be a must-read for everyone involved with Wall Street, is the music, put together to go with it by This American Life (h/t Daily Intel).

However, we already knew that John Paulson’s Paulson & Co, together with Goldman Sachs, Deutsche Bank and other banks, had done something similar. But the scale of the Magnetar CDO creation seems to set it apart: it sourced the bulk of the CDO market in late 2006, shorting some of the CDO debt it had helped create while buying the super-toxic CDO equity, which CDO creators usually found tough to shift. Its losses on the equity were in at least one case more than covered by the eventual profits from the debt when the CDO tanked, ProPublica reports. Worth noting is Magnetar’s explanation: it insists it was net long all its own CDOs, which means it would lose money when they defaulted, and that it ran a market-neutral strategy, meaning it aimed to make money whether the mortgage/CDO market went up or down.

James Mackintosh

So, from the dream team that brought Barclays through the financial crisis without a bail-out (as John Varley and Bob Diamond might like to be described), come proposals to buy an American retail bank.

Three reasons why Barclays, one of Britain’s biggest banks, should not be trusted with such a deal:

1. Barclays wanted to be Royal Bank of Scotland. It tried to buy ABN Amro, and was only stopped by a combination of RBS’s willingness to pay even more than the insane sum (€64bn) Barclays offered and a campaign by Atticus Capital, the New York hedge fund, to make it see sense. Had Barclays succeeded, it would be Varley, not Sir Fred Goodwin, who was having his windows broken.

2. Barclays almost became a combination of Lloyds TSB and Bank of America. If it hadn’t been for Alistair Darling and the FSA, Barclays would have bought Lehman Brothers the weekend before it went bankrupt, in a sweetheart deal brokered by Hank Paulson, then Treasury secretary, and Tim Geithner, then head of the New York Fed and now Treasury secretary. Had Barclays succeeded, Varley would be joining Eric Daniels of Lloyds (now Lloyds Banking Group, following its disastrous HBOS takeover and state bail-out) and Ken Lewis (ex) of BoA (the not-so-proud owner of Merrill Lynch) in the competition for the title of worst takeover deal ever. [EDIT: Note that a large chunk of the most toxic assets would have been left for Wall Street to pick up; bad assets embedded in the balance sheet would still have been terrible news for Barclays, but perhaps - perhaps - it could still have avoided falling under state control.]

3. Barclays is already too big to fail. Allowing it to grow bigger simply exposes the British taxpayer to further contingent risk, which quite clearly Britain is not capable of taking on.

In addition, the dismal history of British banks in the US gives good reason for caution: most famously HSBC, but RBS of course had big operations there and NatWest Bancorp was never successful.

Rather than letting Barclays buy more, it should – as with other big banks – be forced to shrink, ideally by making it pay its true cost of capital, which would render many operations of all the banks unprofitable.

James Mackintosh

Here we go again. Germany, France, Spain, Greece and Portugal are talking about extra regulations on credit default swaps, the insurance-like derivatives that let investors bet on debt problems, accusing the international media of a conspiracy or shouting about “speculators”. Some of the more excitable reports even suggest governments have called in the secret services to keep an eye on the hedge funds, although in typical German fashion Berlin called in its financial regulator, instead.

New regulations are already being mooted, with Jean-Claude Juncker, who chairs the eurozone finance ministers, warning of “torture equipment” ready to be used against speculators. But we’ve been here before. At the height of the banking crisis, short-selling bank equity (and in the US much other equity too) was banned, as short-sellers were blamed for the problem – including by John Mack (head of Morgan Stanley, then the biggest servicer of hedge funds wanting to short) and the Archbishops of York and Canterbury (the Church of England invested in hedge funds).

It is true that aggressive, co-ordinated short selling could create a problem at a bank by damaging confidence, starting a run on its short-term funding. But that could only create a liquidity problem. It turns out, of course, that the short-sellers were shorting precisely because there was already a confidence problem caused by the (correct) belief that the banks had a solvency problem. If there was any co-ordinated shorting – which remains unproven, but is being investigated – that was not the problem.

In Greece, the same argument applies. Is a loss of confidence causing the problem, or is the Greek economy like souvlaki – totally skewered?

A loss of confidence is much harder in a country than a bank: you can’t have a run. But theoretically the price of raising sovereign debt, and so commercial debt, could be pushed up, costing the country more. This is happening – but it isn’t happening because of the “shorting” effect of hedge funds buying CDS protection.

Quite the opposite. Hedge funds are – or at least were – buying CDS protection years before the problems emerged, because they believed the market had too much confidence in Greek debt. Greece is a serial defaulter, had a credit-fuelled bubble created by importing German interest rates, and saved far too little.

On top of that, Adair Turner, chairman of Britain’s Financial Services Authority, on Tuesday pointed out that short selling was not the big deal it is being made out to be. He is no fan of CDS – he has warned several times that some financial instruments are “not socially useful” – but he is also pragmatic, having been happy with the short selling ban on banks.

Here’s what Turner told MPs, according to Reuters:

It is important that even if we look at this issue we don’t overstate it. A fundamental issue that can drive volatility on spreads on Greek bonds is a whole load of long investors not being willing to buy.

I believe the total amount of CDS short positions in the area of Greek problem debt is only 3-4 per cent of outstanding Greek sovereign debt. The biggest driver is confidence levels and actions of long investors.

In other words, pension funds and other “good” investors are shy of buying Greek debt, not surprisingly. So not only is it not bad that hedge funds were shorting Greek debt, they weren’t even driving down its price by doing so. The current bail-out talk is already creating the risk of a short squeeze, bringing in spreads, as the WSJ points out.

None of this is likely to stop eurozone finance ministers blaming nasty foreign Anglo-Saxon casino capitalists for their troubles; some hedge funds closed out their short positions on troubled countries weeks ago because they feared exactly this political intervention (although they are now shorting the euro as a whole instead).

However, there is a genuine debate to be had about whether the use of CDS to take speculative positions, rather than simply to hedge existing positions, should be banned. Taking out insurance on something you do not own (which is akin to a “naked” CDS trade) is banned precisely because it creates the incentive to do what you can to damage the thing insured – in this case Greek debt. Plenty of people have argued CDS should be treated on a par with other forms of insurance, famously including Warren Buffett and most recently James Rickards, the former LTCM general counsel, and FT columnist Wolfgang Münchau.

I tend to the view that the incentive is different to fire insurance, and best controlled through regulation; owners of shares, after all, have an incentive to drive up the price through foul means, which we are quite happy to see controlled through regulation. But perhaps the CDS market cannot be made transparent enough, and liquid enough, to prevent it being used for large-scale manipulation, in which case it should be restricted.

In Greece, though, it does not appear to be manipulation by hedge funds which is causing the wide bond spreads. So finance ministers should address their problems at home, before trying once again to turn speculators into scapegoats.

James Mackintosh

The campaign to persuade the British people that they the banks should pay a new tax is backed by charities – but it is funded by them too.

A smart (but rather offensive) reader of Guido Fawkes looked up the “Robin Hood Tax” campaign’s web site, and found that Comic Relief, the charity behind the country’s much-loved Red Nose campaign, had paid for it.

I happen to think the tax is a bad idea, but I accept that plenty of very clever people would like to see it implemented. Whatever your views on the tax, it is reasonable to ask whether this is an appropriate way to spend charity money – even if it is only a small amount of money.

James Mackintosh

Some smart hedge funds have already pulled out of the crushing attack on Greece, fearing that the market logic could be ovewhelmed by political intervention, as I pointed out earlier this week.

On Thursday night Christine Lagarde raised exactly this issue on the BBC (link may not be accessible from outside the UK).

Asked what message the eurozone countries wanted to send to “speculators”, she said (my transcription):

Number one I think they had better be careful. There is clearly a statement of solidarity – we are closing ranks. Whether we are big member states or small member states we are all in this together and we are not going to let any of us down. That’s point number one.

Point number two, I think that, you know, what we are going to take away from this crisis is certainly a second look at the validity, the solidity of CDS on sovereign debt. Clearly we need to look deeply at that and propose changes.

Number three, it confirms our determination to actually bring more transparency into this equation.

James Mackintosh

Richard Curtis, Britain’s most successful comedy scriptwriter, wants to rebrand the Tobin Tax as the Robin Hood Tax, to take 0.05% from every international financial transaction and put it into a $400bn fund for, umm, good stuff like education, tackling poverty and climate change.

Nice rebranding: the opposite of the US estate tax or British inheritance tax being dubbed the death tax. Perhaps the same job could be done for income tax, to salve the consciences of payers: the “happiness levy”, perhaps.

But does it make sense? No. Is there one good thing about it? Not really: even the Bill Nighy video is disappointing.

Proponents think it would work by discouraging “excessive” trading, such as computer-driven rapid-fire share trades or the high volumes of speculative currency trading. There are a lot of smart supporters: Lord Turner, George Soros (who thinks it is unfair to tax retail sales but not capital flows) and Warren Buffett among them.

But large volumes of trading aren’t a problem, as long as they are adequately backed by capital (something currently being fixed, hopefully, in Basle), and as long as all the smart engineering PhDs in the world aren’t sucked into Wall Street (which could be fixed by reducing bank profits, through higher capital requirements and by forcing the banks to pay their true cost of capital). If there are profitable trades which do not provide any social benefit, as Lord Turner asserts, it is because the money is made available for the trades at below its true cost – so there is effectively a state subsidy. Don’t tax the trade: take away the subsidy, the state bail-out guarantee. Willem Buiter argued this at greater length a while ago.

On top of that, just because Gordon Brown and Nicolas Sarkozy agree it is a good idea, that don’t make it so – and it doesn’t make it possible to introduce internationally either, as Toby Young points out.

Even if it were somehow introduced internationally, how would the rate be set? Curtis suggests 0.05%, or 5c for every $100 trade – peanuts, he and Nighy imply. I don’t think it is peanuts (hence the vast sums raised), but even if it were, just look to Europe to see how taxes only go one way: up. You don’t have to be a right wing American to believe that the rate would be jacked up over time.

Finally, how is the money going to be spent?

The plan is for the US$400bn that could be generated by a global Robin Hood Tax to be split equally, with $200bn spent domestically and $200bn spent around the world.

Of the money spent globally, $100 billion would go towards international development and US$100 would support developing countries as they adapt to climate change.

The $200bn to be spent domestically would make serious inroads into tackling the structural factors that mean more than 13 million people in the UK live in poverty

Sounds great. Except, umm, why would the $200bn be available to the UK? Surely it would be divided between the whole world? Would Britain get half on the grounds that the City dominates foreign exchange, the biggest international market? No. How much would it get?

6.7bn people in the world, so $29 each (no, I didn’t do that in my head). Alternatively, if Britain tries to keep all the money, other countries are guaranteed to respond by cutting their “Robin Hood” rate, to attract the City’s business – it is highly mobile, after all. If all Britons get is $29 each, at the risk of destroying the City, that isn’t worth it. If there was a way to secure $200bn, or $3,278 each, that would be great – but there isn’t.

On top of that, the developing country and climate change money would be put in the hands of the UN. Yes, you heard right: the UN.

Funds would be managed by a UN mechanism, to ensure they are allocated fairly and according to each country’s particular needs.

Expect much corruption in a process overseen by the UN? Well, take a look at the UN-administered oil-for-food regime in Iraq, pre-invasion. According to the US DoD, there were $4.4bn of illegal surcharges (plus the smuggling). A Robin Hood Fund might be differently structured, but with many of its members cocking a snook at the rule of law, what chance would a UN fund have of staying corruption-free?

So far, Curtis doesn’t seem to be getting overwhelming support. After filtering out an attempt to fake massive no votes (ROFL, as geeks used to say), the results at 8.25pm were:

YES: 9850 votes
NO: 1846 votes

Given the amount of effort put into the campaign, that seems pretty disappointing for Curtis – but is good news for the financial system.

James Mackintosh

In the hunt for hedge funds profiting from the Greek crisis and the contagion spreading into Spain, Portugal, Greece, Ireland and the euro, the obvious candidate has been ignored.

Mark Hart, based in Fort Worth, Texas, was the first to set up a dedicated fund to bet on problems within the eurozone, at the end of 2007.

His European Divergence Fund, run in partnership with GaveKal, the Hong Kong-based analysts who have a separate joint venture with London’s Marshall Wace, has done fabulously well from the crisis thanks to its early bet that the eurozone was unstable.

“The thesis was that European credits should not all be trading as if they were one, because they have divergent economies,” says one investor. “On top of that the conditions [for entry] were fudged.”

James Mackintosh

The start of work on an expensive new headquarters often marks the high tide for a company, from Time Warner and the New York Times through Volkswagen (with its VW Autostadt) and others.

So it is appropriate that it was only in December that the European Central Bank announced plans to press ahead with a new €500m HQ. The headquarters curse has already hit: the break-up of the eurozone headed by the ECB has become the subject of frenetic discussions following the financial crisis in Greece and the spread of worries to Spain and Portugal. The value of the single currency has plunged from an 18-month peak of $1.50, almost exactly on the day of the HQ announcement, to $1.37. Hedge funds have record levels of short positions betting on further declines, as the Greek financial crisis infects Spain and Portugal.

Euro decline

Many outside the single currency region are gloating, highlighting the unsustainable pressures caused by putting countries with such different performances as Greece and Germany under the same monetary regime. They are wrong to do so: the crisis may be bad for the euro but that is bad news for competitors, such as the US and UK, too.

In effect, prices of exports to the eurozone countries have risen about 9% since December. The new weakness of the euro will hinder the growing US export machine, and stamp on the green shoots of manufacturing confidence in Britain. In the race to export themselves back to health, Britain and America just lost their advantage. The only consolation is that the euro is reversing some of its gains, and had been a lot weaker a year ago.

James Mackintosh

It isn’t just touchy government ministers in Portugal, Italy, Ireland Greece and Spain who don’t like the highly appropriate acronym PIGS to sum up the troubled regions of the eurozone (the ‘i’ seems to be used for Ireland and Italy). The FT has a near-ban on the insulting phrase, and now Barclays Capital has banned it too, for being offensive.

Luckily there’s a handy alternative for excessive borrowers (thanks Zerohedge): STUPID. It pulls together Spain, Turkey, the UK, Portugal, Italy, and Dubai. Sadly Greece, Iceland and Turkmenistan are missing…

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Politics, economics, high finance and morality – this blog addresses the issues being considered by the FT’s comment team, and their thoughts.

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Christopher Cook is an FT editorial writer. Before joining the FT in 2008 as a Peter Martin Fellow, he worked for three years for the Conservative party.

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