On Sunday a former Senior Deutsche Bank manager, William Broeksmit, was found hanged at his house. He was the retired Head of Risk Optimization for the bank and a close personal friend of Deutsche’s Co-Chief Executive, Anshu Jain. Mr Broeksmit became head of Risk Optimization in 2008. He retired in February 2013.
Early this morning, Gabriel Magee, a Vice President of CIB (Corporate and Investment Banking) Technology at JP Morgan jumped to his death from the top of the bank’s 33 story European Headquarters in Canary Wharf. As a VP of CIB Technology Mr Magee’s job would have been to work closely with the Bank’s senior Risk Managers providing the technology which monitored every aspect of the bank’s exposure to financial risk.
These deaths could well be completely unrelated and just terribly sad for their respective families. On the other hand neither of these men had any obvious problems and both were immensely wealthy. So why would two senior bankers commit suicide within a couple of days of each other?
One place to start is to note that JP Morgan Chase had, at the end of 2012, a mind boggling, but only silver medal, $69.5 Trillion with a ‘T’ gross notional Deriviatives exposure . While the gold medal for exposure to Derivative risk goes to …Deutsche Bank, with $72.8 or €55.6 Trillion Gross Notional Exposure. Gross Notional means this is the face value of all the derivative deals it has signed. Which the bank would be very quick to tell you would Net Out to far, far less. Netting Out, for those of you who do not know just means that a bet/contract in one direction is considered to balance or cancel out a similar sized bet/contract betting the other way. But as I wrote in Propaganda War – Risk Weighted Lies and further in Propaganda Wars – Balance Sheet Instabilities ,
…this sort of cancelling out is fine on paper but in reality is more akin to people trying to swap sides in a rowing boat.
Both of the men who killed themselves were intimately concerned with judging and safeguarding their bank from risk.
To give you an idea what sort of risk that size of a derivatives book is consider that the entire GDP of Germany is €2.7 Trillion. Remember that Derivatives are what Warren Buffet dubbed “weapons of financial mass destruction.”
Next question might be, when do these weapons become dangerous? The answer obvioulsy varies in accordance with the type of derivative you are considering. One huge group of derivatives that both JP Morgan and Deutsche both deal very heavily in are currency and interest rate swaps. They become dangerous when there are large moves in currency values and interest rates.
At the moment The Tukish Lira has been in free fall for days. The Turkish central bank tried to defend it and could not stem an unstoppable tide. It then stunned everyone by raising its over-night lending rate (the interst rate it charges to lend to banks over-night) from 4.25% to 12 %!
This did not work either and today the Lira continues to be in crisis, as is the whole Turkish stock market.
The Hungarian Florint is also crashing. As is the entire Argentinian economy. The Peso fell 10% in a single day recently. At the same time there is massive uncertainty surrounding Ukraine as there is also surrounding the interest rates and stability of South Africa.
So imagine you are a large bank with huge derivatives business much of which covers bets in your equally large Foreign Exchange business. Essentially that boat in which you are hoping you can ‘net out’ about 70 Trillion dollar’s worth of derivatives positions is now being bounced about by several large storms.
Many of those derivatives contracts would have been entered into during Mr Broeksmit’s tenure at Deutsche, while Mr Magee would have been overseeing and advising on his bank’s risk exposure as it swayed about over at JP Morgan.
All in all I don’t think it is far fetched to think both these men may have been under huge strain and possibly more afraid than the rest of us, because they were in prime position to know much more than the rest of us.
All of which brings to mind yet another banker who recently fell to his death.
Just under a year ago, in March of 2013, David Rossi, head of communications at one of Itay’s largest and most catastrophically insolvent banks, Monte dei Paschi, fell from the balcony of his third story office at the bank’s head-quarters. How a man who isn’t drunk and who, as far as I am aware, left no suicide note just ‘falls’ from a balcony is a mystery. But the Italian authorities, I have no doubt, did a bang up job.
Monte dei Pasche…had engaged with shady derivatives deals with Deutsche Bank to cover up hundreds of millions of euros in loses, and then employed some creative accounting to hide the trades from share holders and the public.(My emphasis).
Now what I find strange about this man’s death is that as Head of Communications he would not have done any banking himself. Therefore, he would not have been guilty of any wrongdoing. So why would he kill himself? It seems to me the worst that could have happened to him is that he became aware of rather serious wrongdoing that other people and other banks even, might have not wanted brought to light….
And then I remembered one more death. Pierre Wauthier, the former Chief Financial Officer (CFO) of Zurich Insurance Group hung himself last year, at his home. Now this death you might think has no possible connection with the others. In fact it has two. Both are, as with the rest of what I freely admit is a speculative piece, circumstantial.
The CEO of Zurich Insurance group at the time of Mr Wauthier’s suicide was Josef Ackermann, former CEO of Deutsche Bank. Mr Ackermann resigned shortly after it was revealed that Mr Wautheir, in his suicide note, had named Mr Ackermann. According to Mr Wauthier’s widow it was Ackermann who had placed her husband under intolerable strain. Of course we don’t know what the issue was that caused the ‘intolerable strain’. But let’s look a little closer at what tied these two men together.
Mr Ackermann stepped down as CEO of Deutsche Bank in 2012 after ten years at the helm. During that time he had transformed Germany’s largest bank from a large but slightly dull national player into one of the very largest and most agressive of the global banks. One of the ways Ackermann had grown Deutsche so spectacularly was to make it the world’s largest player in the derivatives market. Nearly all of that 72 Trillion dollars’ worth of derivative exposure was accumulated under his leadership.
Mr Ackermann had built a derivatives position 18 times larger than the GDP of Germany itself.
A year and a half after Mr Ackermann took over at Zurich Insurance Group, Zurich announced it was going to start offering banks a way of holding less capital against their risky assets/loans by offering to insure or ‘buy’ the risk from them. This is know as Regulatory Capital Trade. As one of the archtiects of the trade was quoted at the time,
“We are looking at products where banks would buy insurance for their operational risks issues. These are normally risks that are not covered by traditional insurance.”
This new insurance venture was, on the one hand, in response to the European regulators insisting that banks had to hold more capital against their risky assets and on the other, a result of the dire need of Insurers to find products that could yield them a profit. The trade is a classic result of a period of extended low interest rates where traditionally safe investments like Soveriegn bonds and vanilla loans and securities just don’t pay enough to cover insurers’ needs let alone let them make a tidy profit. In other words those insurers who understood what banks were exposed to and were willing to take the risk on themselves – because they thought they were cleverer – could find yield where others feared to tread. And of course one of the largest pots of risky assets on bank books is derivatives. All those lovely foreign exchange bets and interest rate bets, and derivative trades which underpin the rapidly growing European ETF market (in which guess who is a massive palyer? Yes, that’s right, Deutsche) – they would all have levels of risk the banks would love to off-load.
Holding more capital against risk might be prudent but it is hell on bank growth and bonuses. Regulatory Capital Arbitrage, is how you game (quite legally, of course) that particuar regulation. The bank gets to keep the underlying asset, while the risk is ‘sold’ to or insured by (depends on how you account for it at both ends) someone else. In this case Ackermann’s Zurich Insurance Group.
In some ways it was a creative move – in the way finance is creative , like making a better land mine I suppose – since Zurich already ran the world largest derivative trading exchange, Eurex. With the new trade Zurich would not just be running the exchange but would now become a major player in the risk trade. Of course this is fine so long as the risk never materializes. Which brings us back to the present spreading turbulence in markets from Ukraine, to Argentina and Turkey. It is also worth noting Zurich also offers insurance against about 50 or so emerging market banks going under. Might not seem quite so safe a market to be in just at the moment.
As Chief Financial Officer Mr Wauthier would have had to be on side with Mr Ackermann about the wisdom of this bank-risk insurance trade.
Now I realize, as I said above, that this is all circumstantial and speculative. But derivatives are, as Warren Buffett said, very dangerous. Deutsche is sitting on the world’s biggest pile of them and J P Morgan the second biggest pile. And right now global events are making those risks sweat. When HSBC tries to limit cash withdrawals and so does one of Russia’s largest banks then something somewhere is not healthy. We are , I think, circling around another Morgan Stanley moment.
The Islamic State of Iraq and the Levant has pledged allegiance to al-Qaeda [AP]
|Turkish fighter jets have hit a convoy belonging to the al-Qaeda-linked Islamic State of Iraq and the Levant (ISIL) in northern Syria, according to a local media report quoting a statement from the Turkish military.A report on Turkey’s Todays Zaman website said that Turkish F-16s struck a number of ISIL vehicles “after militants opened fire on a military outpost” on the Turkey-Syria border on Wednesday.
Broadcaster NTV said Turkish troops opened fire on the ISIL positions after a mortar shell fired from Syria landed in Turkish territory during clashes between ISIL and the Free Syrian Army.
The broadcaster said a pickup truck, a lorry and a bus were destroyed in the Turkish retaliation, but there were no reports of casualties.
Contradicting Todays Zaman, NTV said the attack occured on Tuesday evening,
Al Jazeera’s Anita McNaught, reporting from Istanbul, said the report, if true, would represent “a considerable and significant escalation” in tensions between Ankara and such groups fighting the regime of Syrian President Bashar al-Assad.
Turkish media have cited a two-day escalation in hostilities between the sides, but until now the Turkish military had only retaliated with tanks and artillery fire, our correspondent noted.
“These are fighters who on many occasions Turkey has turned a blind eye to,” said McNaught. “…Turkey is now fighting against the people [who] they have allowed to pass into Syria.”
Some perspective on the two “alternative currencies” – bullion and bitcoin -from the man who has run a hedge fund for 37 years and currently manages $23.3 billion, Elliott’s Paul Singer.
After 37 years in the investment-management business, we are not easily shocked. However, two things about bitcoin have shocked us recently. One is that bitcoin and some of its fellow alternative currencies are finding such favor among investors while gold (the only real alternative currency) is languishing. The second is that the most heated investment-related conversation we have had in many years was with a young person who, when told of our mild dubiousness toward bitcoin, basically lost it and started yelling in its defense. Bitcoin comes with passion and belief – at least at the moment.
There is no more reason to believe that bitcoin, a computer-generated, algorithm-driven currency of supposed limited supply, will stand the test of time than that governments will protect the value of government-created fiat money. One difference: Bitcoin is newer and we always look at babies with hope.
If you are looking for an alternative currency, look into gold. It has stood the test of thousands of years as a medium of exchange and a store of value. Better yet, it is not just a computer entry out in the ether somewhere, and it was last seen available at a good price.
Bitcoin and its relatives speak to understandable impulses (against big government, in favor of freedom and modernity), but we do not see this particular experiment lasting. At least you have to work really hard to dig gold out of the ground.
January 29, 2014
I have an old acquaintance named Sam who has a hell of a deal for you.
Sam is actually a pretty famous guy with a big reputation. Unfortunately he has been a bit down and out on his luck lately… but he’s trying to make a comeback. And Sam is prepared to float you a really great investment opportunity.
Here’s the deal he’s offering: you give Sam your hard-earned retirement savings. Sam will invest your funds, and pay you a rate of return.
Granted, the rate of return he’s promising doesn’t quite keep up with inflation. So you will be losing some money. But don’t dwell on that too much.
And, rather than invest your funds in productive assets, Sam is going to blow it all on new cars and flat screen TVs. So when it comes time to make interest payments, Sam won’t have any money left.
But don’t worry, he still has that good ole’ credibility. So even though his financial situation gets worse by the year, Sam will just go back out there and borrow more money from other people to pay you back.
Of course, he will be able to keep doing this forever without any consequences whatsoever.
I know what you’re thinking– “where do I sign??” I know, right? It’s the deal of the lifetime.
This is basically the offer that the President of the United States floated last night.
And like an unctuously overgeled used car salesman, he actually pitched Americans on loaning their retirement savings to the US government with a straight face, guaranteeing “a decent return with no risk of losing what you put in. . .”
This is his new “MyRA” program. And the aim is simple– dupe unwitting Americans to plow their retirement savings into the US government’s shrinking coffers.
We’ve been talking about this for years. I have personally written since 2009 that the US government would one day push US citizens into the ‘safety and security’ of US Treasuries.
Back in 2009, almost everyone else thought I was nuts for even suggesting something so sacrilegious about the US government and financial system.
But the day has arrived. And POTUS stated almost VERBATIM what I have been writing for years.
The government is flat broke. Even by their own assessment, the US government’s “net worth” is NEGATIVE 16 trillion. That’s as of the end of 2012 (the 2013 numbers aren’t out yet). But the trend is actually worsening.
In 2009, the government’s net worth was negative $11.45 trillion. By 2010, it had dropped to minus $13.47 trillion. By 2011, minus $14.78 trillion. And by 2012, minus $16.1 trillion.
Here’s the thing: according to the IRS, there is well over $5 trillion in US individual retirement accounts. For a government as bankrupt as Uncle Sam is, $5 trillion is irresistible.
They need that money. They need YOUR money. And this MyRA program is the critical first step to corralling your hard earned retirement funds.
At our event here in Chile last year, Jim Rogers nailed this right on the head when he and Ron Paul told our audience that the government would try to take your retirement funds:
I don’t know how much more clear I can be: this is happening. This is exactly what bankrupt governments do. And it’s time to give serious, serious consideration to shipping your retirement funds overseas before they take yours.
(Note to members of our PREMIUM service: look for an upcoming actionable alert on this topic).
Consensus that the Fed would extend its $10bn taper from December with a further $10 bn taper today (reducing the monthly flow to a ‘mere’ $65 billion per month – $30bn MBS, $35bn TSY) was spot on. We suspect the view, despite the clear interconnectedness of markets (and flows), of the FOMC is that “it’s not our problem, mate” when it comes to EM turmoil.
- *FED TAPERS BOND BUYING TO $65 BLN MONTHLY PACE FROM $75 BLN
- *FED SAYS LABOR MARKET `MIXED,’ `SHOWED FURTHER IMPROVEMENT’
Of course, “communication” was heavy with forward guidance on lower for longer stressed. We’ll see if the market buys the dichotomy of hawkish real tapering and dovish promises…remember “tapering is not tightening.”
Pre-FOMC: S&P Futs 1775, Gold $1267, 10Y 2.71%, 2Y 35.5bps, USDJPY 102, EM FX 85.67, WTI $97.35, IG 72bps, HY $106.35
Perhaps this chart from Saxo Capital Markets ( @saxomarkets ) sums up the world best for now…
Full redline below…
“A Funny Old World” – The EM Carry Trade Collapse ‘Deja Vu, All Over Again’ From Citigroup | Zero Hedge
Spot the similarities.
From CitiFX Technicals: It’s a funny old World
- 1989-1991: Housing and savings and loan crisis: Fed eases aggressively as economy enters deep recession
- 1992-1994: Existing financial architecture in Europe (ERM) blows apart
- 1995-1998: European convergence trade in both FX and Bond spreads keeps European currencies relatively stable vis a vis the USD with a good rally in 1998.By 1996 BUBA has lowered the discount rate to 2.5% while US rates remain well below the pre-crisis highs of 9.75% in 1989.
- The carry trade and capital flow into emerging markets (Asia in particular) is center stage
- March 1997: In a seemingly “innocuous” move the Fed “tinkers” by raising rates 25 basis points.
- April 1997: Japan raises its consumption tax as USDJPY has rallied from a post Kobe Earthquake low of 79.7 to 127.50 . USDJPY collapse to 111 by June
- June 1997-Jan 1998: Severe reaction in Asian currencies as “hot money flees”
- August-October 1998: Russia defaults, Long term capital folds and the Fed eases aggressively as the Equity market drops 22% (S&P)
History may not repeat…..but it sure RHYMES
It’s deliciously ironic that emerging market (EM) problems have flared so soon after the meeting of the rich and powerful in Davos. According to the central bankers at Davos, the financial crisis is behind us and brighter days lay ahead. According to these bankers, the EM issues which have since arisen are confined to a handful of developing countries and they won’t impact the West.
If only were that so. What the eruptions of the past week really show is that the system based on easy money created by these bankers remains deeply flawed and these flaws have been exposed by moves to tighten liquidity in the U.S. and China. The system broke down in 2008, and again in Europe in 2011 and now in EM in 2013-2014.
The market reaction to the latest events has been abrupt and violent, particularly in the currency world. In my experience, markets generally cope well when there is one crisis. If the current issue was isolated to Turkey, markets outside of this country would probably shrug their shoulders and move on. But when there are multiple spot fires like the last week, markets don’t cope as well.
What are investors supposed to do now? Well, going into this year, Asia Confidential suggested (here, here and here) being cautious on stocks given increasing deflationary risks from U.S. tapering and a China slowdown. And to go long government bonds in developed markets (the U.S) given these risks and junior gold miners due to the extraordinarily cheap valuations on offer. These recommendations have performed well year-to-date and should continue to out-perform for the remainder of 2014.
Simple explanations for the crisis
Much ink has been spilled (or keyboards worn, in this day and age) trying to make sense of the past week’s event. China’s economic slowdown has copped much of the blame. As has QE tapering. And idiosyncratic issues in Turkey and Argentina have received their fair share of attention.
There have also been more sophisticated explanations such as this one from Kit Juckes at Societe Generale:
“There has been a shift in the balance of growth as Chinese demand for raw material wanes, and as higher wages and strong currencies make many EM economies less competitive. Meanwhile, the Fed policy cycle IS turning, and 4 years of capital being pushed out in a quest for less derisory yields, are ending. This isn’t a repeat of the 1990s Asian crises, because domestic conditions are completely different but it is a turn in the global market cycle. We need to transition from a world where investment is pushed out of the US/Europe/Japan to one where it is pulled in by attractive prospects. When that happens, flows will be differentiated much more from one country (EM or otherwise) to another. But for now, we’re just waiting for global capital flows to calm down.”
Now I have a large issue with the purported attractive prospects of the US, Europe and Japan, but let’s put that aside. The bigger issue is that the explanation here appears to be addressing the symptoms of the crisis (global capital flows) rather than the disease (excess credit and an unstable global economic system).
A more nuanced view
Let me elaborate on this. In a previous post, I echoed the thoughts of India’s new central bank chief in suggesting that there were four main causes for the 2008 financial crisis:
- Rising inequality and the push for housing credit in the U.S.. Growing income inequality in America, exacerbated by technology replacing low-wage jobs and an inadequate education system which failed to re-skill people, led to politicians allowing easier credit conditions to boost asset prices and make people feel wealthier. That resulted in the subprime and housing crisis.
- Export-led growth and dependency of several countries including China, Japan and Germany. The debt-fueled consumption in the U.S. would have been inflationary were it not for these countries not meeting the consumption needs of Americans. In other words, they aided and abetted the consumption binge in the U.S.
- A clash of cultures between developed and developing countries. This relates back to 1997 when the Asian crisis force countries in the region to go from being net importers to substantial net exporters, thereby creating the conditions for a global glut in goods.
- U.S central bank policy pandering to political considerations by focusing on jobs and inflation at any cost. The bank acted in accordance with the wishes of politicians by keeping interest rates too low for too long. They did this to maintain high employment, one of the bank’s two central mandates.
It’s important to note that none of these issues has been resolved. In fact, many of them have worsened. And any hint of adjustments to one or more of these problems results in further crises (like Europe in 2011 and in EM mid-last year and today).
This isn’t to excuse the governance issues in the likes of Argentina and Turkey. But it is to suggest that they are merely symptoms of a deeper malaise.
Deflation is winning battle over inflation
If these adjustments were to happen in full, it would result in plunging global asset prices as excessive debt loads are unwound. De-leveraging, in economic terms. This deflationary action is anathema to the world’s central bankers as deflation is enemy number one. Hence, they’ll do “whatever it takes” to produce inflation. And if that means flushing currencies down the urinal, so be it. The battle between inflation and deflation is ongoing, though the latter has the upper hand right now.
The weapons of choice for central bankers to fight off deflation are QE and zero interest rates. Central bankers tell us that these policies are necessary for economies to heal. I’d suggest this is baloney and they’re exacerbating the aforementioned problems.
To see why, it’s important to understand that interest rates are the central price signal off which all assets are priced. If central banks keep rates artificially low, it distorts these asset prices. And if you keep rates low for long enough, it distorts prices to such an extent that it’s impossible to know what the real value of certain assets are.
Another issue is that by keeping rates low, businesses which should go bankrupt stay alive. That’s why government bail-outs of almost any private company are a bad idea. Keeping zombies businesses alive means economies become less competitive over time. Witness Japan since 1990.
These are but a few of the unintended consequences of the current policies.
There are three possible endgames to the current situation:
- There’s a global deflationary shock where all asset prices fall and fall hard. A la 2008. In this instance, central banks would go in all guns blazing with more money printing on an even grander scale. This would risk inflation if not hyperinflation as faith in currencies is diminished, if not lost.
- You have a gradual global recovery and inflation stays tame enough for a smooth exit from current policies.
- There’s a recovery but central banks are slow to raise rates and inflation gallops, which forces tightening and a subsequent economic slowdown.
My bet remains on the first scenario given intensifying deflationary forces from a China economic slowdown and Japan currency debasement (which aids exporters in being more price competitive).
If I’m right, there may be deflation followed by extreme inflation (or one quickly followed by the other). That makes investing a tough game. Under both of those scenarios, stocks and bonds would under-perform in a big way (my current call to own developed market government bonds is a 6-12 month one, not long-term). That’s why cash (which would out-perform in deflation), gold (which would prosper under extreme inflation) and select property and other tangible assets such as agriculture (which may out-perform under extreme inflation on a relative rather than absolute basis) should be part of any diverse investment portfolio.
This post was originally published at Asia Confidential:
With all eyes on Russia over the next month as the Sochi Winter Olympics ramps up, we are sure having the market’s attention on a collapsing currency is not what Putin had in mind before he dropped $50 billion to make it snow. While the Ruble remains just above record lows against the USD, Bloomberg reports that it has dropped to a record low against the central bank’s dollar-euro basket. Russia’s finance minister proclaimed today (Erdogan style?) that Bank Rossii should not raise rates (which has been unchanged at 5.5% for the last 15 months). Russian CDS is widening (193bps at 4 month highs) but not cratering like other EM currencies but MICEX (stocks) have had their longest losing streak since April.
As Bloomberg adds,
The ruble depreciated 1.2 percent to 40.9632 versus the central bank’s dollar-euro basket by 6:01 p.m. in Moscow. A weaker ruble encourages Russians to withdraw and convert local- currency deposits, Sberbank’s main source of funding, while hurting retailers by making imports more expensive in ruble-denominated prices.
“Investors are scared of the ruble devaluation,” Sergey Vakhrameev, an analyst in Moscow at AnkorInvest LLC, which manages about $30 million in assets, said by phone. “During strong devaluations, stock markets fall, investors become scared of indexes in countries where the devaluation isn’t controlled.”
Of course, this will only make the bank run problems worse…
Do you want to know what the future looks like? Try Australia, where bats falls dead out of the sky, and tennis players drop like flies in the heat. Coming right up: a report from the hot front with Cam Walker, Friends of Earth Australia.
Then we’re back to sky science. Atmospheric rivers move below the Jet Stream, carrying more water than the Amazon, and dumping it suddenly causing floods below. Expert David Lavers explains.
Then it’s journalist and author Alan Weisman. His previous book looked at the world without us. Now it’s Countdown, Our Last, Best Hope for a Future on Earth. Are we headed for biological burnout?
Wiradjuru, Murray-Darling Basin, Australia image via oxfam/flickr. Creative Commons 2.0 license.