Bank Hedges and Social Justice

by  Chidem Kurdas

To hedge or not to hedge? That’s the question for many an endeavor. Farmers hedge by selling their harvest ahead of time. Building managers hedge by locking in a price for heating oil or natural gas—last year many got it wrong, blindsided by the decline in the price of gas. Most hedges we don’t hear much about.

Until last week, the most infamous hedge was the set of complex trades put on by Goldman Sachs as protection against losses in mortgage securities in the property bust. Financially this worked and Goldman Sachs escaped the 2008 crisis relatively unscathed. Thereupon it became an object of loathing and mockery in the media, inspiring calls for higher taxes and greater regulation.

Now we have the failed trades with resultant loss of $2-$3 billion at JP Morgan Chase. This also inspired calls for greater regulation, in particular of bank trading, which appears to be offensive whether it makes money or loses money.

Big Bank Obesity Conundrum

by Chidem Kurdas

Is the Federal Reserve a hotbed of trustbusters? Fed officials (as well as some academics) have been calling for forcible downsizing of big banks . “I am of the belief personally that the power of the five largest banks is too concentrated,” Dallas Federal Reserve Bank president Richard Fisher said a few days ago during a visit to Mexico, according to news reports. He’s expressed similar views before, as has Thomas Hoenig, former president of the Kansas City Fed.

Here on ThinkMarkets Jerry O’Driscoll, a Federal Reserve veteran, wrote: “There is no conceivable efficiency gain that justifies the risk these gigantic, risky institutions impose on all of us,”

European Bailout’s Scapegoats and the Future

by Chidem Kurdas

Before the near-trillion-dollar bailout package for financially shaky euro-zone governments was announced, French president Nicolas Sarkozy hauled out the financial whipping boys yet again. He promised to “confront speculators mercilessly.” They would soon “know once and for all what lies in store for them,” he said.

Presumably he meant that those betting on the decline of the euro will be squeezed and made to understand that he and his fellow office holders will protect the currency. Thus Mr. Sarkozy framed the issue—we’re not bailing out profligate governments, we’re defending our common currency against demonic speculators.

This message appears to play well politically  But beneficial as it may be in the short term for those in office, it compounds the real problem.

Goldman Sachs Hate Week

by Chidem Kurdas

George Orwell’s classic novel, Nineteen Eighty-Four, describes a political ceremony called the Two Minute Hate, featuring Public Enemy Number One, a reprobate named Goldstein. People attend official rituals to work up a frenzy of hatred against Goldstein and love for their protector, Big Brother, or B-B.

To quote Orwell, at the climax of the Two Minute Hate, “the entire group of people broke into a deep, slow, rhythmical chant of “B-B! … B-B! …B-B!” – over and over again…” This daily rite is supplemented with elaborately prepared Hate Weeks.

In the past week there has been a similar fury in the media against Goldman Sachs, with herds of pundits all expressing their horror of the derivatives deal that is at the center of the Securities and Exchange Commission’s fraud case against the investment bank. This campaign starts with chants of “Social Benefit! Social Benefit! Social Benefit!” and climaxes with “Regulation! Regulation! Regulation!” Thus a mythical regulator stands in for B-B.

To pick one example out of many, George Soros writes that “Whether or not Goldman is guilty, the transaction in question clearly had no social benefit.” Mr. Soros is wise to hedge his bet about Goldman’s guilt—the SEC complaint contains holes the size of the real estate bubble. But was the mortgage-based collateralized debt obligation really devoid of social value?

Beating Bonuses into Risk Controls

by Chidem Kurdas

Deferred vesting of stock options is not a new idea—it gained currency amid the corporate scandals that emerged in the aftermath of the late 1990s stock bubble. It appears to be making more inroads at present, in the aftermath of the twin credit and property bubbles.

This growing practice is not confined to Wall Street, but financial firms are the forefront.  Given that bonuses, and hence stock awards, tend to be by far the largest portion of managers’ pay in the financial industry, the restrictions have the potential for curbing bad behavior in the future.

This may be the one useful result of public anger over outsize compensation and the political grandstanding it has occasioned. It could go some way to reduce the perverse incentive created by the government safety net and cheap federal loans, which are in effect an invitation to put the money to use in lucrative but hazardous ways.

Big Bad Bank and Little Red Trustbuster

by Chidem Kurdas

A surprising new Small-Is-Beautiful movement is afoot.  Mario Rizzo, Jerry O’Driscoll, Harry Kaufman and others make a case for  breaking up too-big-to-fail financial institutions. As Mr. Kaufman puts it, otherwise those companies will become financial public utilities backstopped by the government.

It’s not likely that the 2008 crisis would have been prevented had top investment banks like Goldman Sachs been smaller. Traditional little banks are going down in droves. They fail because real estate loans are going bad. So many depository banks have gone under that the FDIC, the federal agency that insures deposits, itself ran out of money and asked to be bailed out by prepayment of bank premiums.

The same real estate bubble-and-bust hit larger banks through mortgage-backed securities. That’s regardless of size. Moreover, the government does not just bail out big investment banks. It bailed plenty of small savings & loan associations in the 1980s. The concept of “too-big-to-fail” is remarkably elastic.  Consider that GM and Chrysler both received federal aid. Chrysler is a lot smaller, but the political preference is to treat it as too-big-to-fail. Keeping banks relatively small will not stop such bailouts.

That said, there is a serious quandary.