Monday, September 14, 2009

Leverage blessed leverage for certain banks' prop trades and hedge funds

When regulators look to address the fix they need look no further than what HAD always been observable - leverage. Mr Benanke, Mr Paulson, Mr Geithner were each aware of same during the hockey stick era 2003 to 2007 and did what? NOTHING. Mr Geithner protected his NY Fed turf by creating LFIG (The Large Financial Institutions Group), Mr Bernanke gave several prescient speeches as early as 2006, Mr Paulson did what he knew how best to do - a deal for the Street.

When it comes to leverage, for the uninitiated leverage equals borrowed money and when Wall St and certain banks lever they do so for whose benefit? The house, I repeat the house. Not you, not me; but their own traders and executive CASH compensation, last shareholders then somewhere somehow the bond holders of these institutions forgot how to perform due diligence and general creditors and got what they deserved. Mr Buffett in only his sage way, stated a few months back when it comes to leverage, "If you don't owe anyone money guess what ? ( I added that piece) you can't go broke." True then, true today and true tomorrow.

But back to the headline, this writer has maintained that the very increase in leveraged holdings in particular in mortgage backed (and related derivative) securities (for that matter it could have been any asset), gave the rest of the participants IN THAT MARKET signals that they too could and/or should hold even more of the SAME.

After all there must have been more sameness, just like milk right? More homogeneity so relying upon similar data, crunched through similar internal models measuring volatility and correlation to warn when danger (less liquidity) was approaching. However, just as few could react in time to avoid the deadly Indian Ocean tsunami which struck the day after Christmas 2004 the same could be said for certain banks' proprietary trading desks. The question to have been asked was NOT whether a potential tsunami required measurement it was the when not if occurrence of a large earthquake that caused the waves that required measurement. Such that the same underlying mortgage collateral is AND was undeniably in a when not if state.

Leverage, Darkness, Derivatives, Internal Models, CASH Compensation
It's more than a fascination; fascinatin' stuff in certain parts of the country; how could certain
banks and brokers churn out record after record "profit" and pay terrific sums in CASH compensation if they truly competed in transparent markets? Drum beat please...answer? Leverage. And darkness. And derivatives. These securities were largely created, traded, valued over the counter (dealer darkness, indicative levels based upon cherry picked, disclosed trades) and trader CASH compensation upon same; not to you, not to me. I'd be more fascinated to learn how these traders invested these CASH bonuses (and more recent bonus replacement salary increases) - especially the amounts funded by taxpayers - writ you and me.

Another principal agent conflict of interest on the taxpayers (unleveraged) dime; I only wish it was a dramatization.

No comments: