Streetwise Professor

July 10, 2012

The Freddie Krueger Post

Like Freddie Krueger, I’m baaaaaack again, folks.  This time, more regularly, I trust.

Catching up on a few things that have caught my eye since last time-and like Freddie, I brought my knives.

  1. The LIEBOR mess continues to metastasize.  It is now sucking in regulators.  Including Timmy! It appears that the dissembling about LIBOR, TIBOR, EURIBOR, etc., was the worst kept secret in the world’s financial centers.  And let’s pray that’s true.  If the Fed, the Bank of England, etc. DIDN’T know that there was a complete disconnect between the rates that banks reported to the BBA and the rates at which they were actually borrowing (or not)-now THAT would be a reason for panic.  In fact, they were all-bankers and regulators alike-operating pursuant to the Juncker Maxim: “When it becomes serious, you have to lie.”
  2. I detest manipulation of markets, and have made a life’s work of studying it, calling out manipulators, and now and again testifying against them.  But I find it disgusting to hear high government officials in high dudgeon on the subject, when they are in fact often the most outrageous and shameless manipulators.  The most flagrant example: the Lilliputians who are the collective “leadership” of the EU and the Eurozone.  For what else can you call their repeated fudges, misstatements, lies, etc. related to the latest “solution” to Greece’s problems, or Spain’s, or Italy’s, than “manipulation”?  How many billions have changed hands on the EUphoric rallies that occur after the announcement of such solutions, and on the, umm, “retracements” that occur when the truth comes out.  The agreement on a Spanish bailout, and banking regulation changes, that came out of the most recent Summit of the Lilliputians is only the latest example.  Look.  Europe is screwed.  Metaphysically.  The math does not work.  Cannot work. Even mores, the politics cannot work.  The core is empty.  No real deal is possible.  Accept it.  And once you accept it, mock any pronouncement of the next “solution”.  And for God’s sake don’t buy except on the theory that other suckers buy and you will sell out before they do.
  3. FCM Peregrine Financial Group apparently absconded with $220 million of “segregated” customer money.  This is both shocking and depressing 10 months after MF Global.  The scheme has apparently been going on for at least two years.  But the CFTC allegedly gave all FCMs the full anal probe post-MF, and saw-like Sergeant Schultz-NOTHINK! So since they can’t find a rather banal fraud at a middling futures brokerage, it’s truly obvious that they have game to regulate the entire world, and every complex financial institution and complex derivative trade in it.  What could go wrong? No doubt that the Peregrine debacle will lead to calls for more regulation.  Regulation, the only human activity where failure is the primary justification for more of it.
  4. The CEO of inter dealer broker GFI, Mike Gooch, has said that hedge funds need to become liquidity suppliers/market makers in order to fill the gap left by banks, post-Volcker Rule.  I predicted this would be the outcome in a couple of posts written soon after the rule was mooted.  There is a serious question here: will this really lead to greater stability during times of financial turbulence?  Given that credit to hedge funds-which comes largely from banks, by the way (funny thing, that!)-typically contracts severely during periods of such turbulence, their market making activities are likely to contract as well during such times.  Meaning that market liquidity supplied by hedge funds will be highly pro-cyclical.  Bank supplied market liquidity is too, but the ones subject to the Volcker Rule-you know, the ones who have sticky insured deposits-are likely to be able to resist these cyclical pressures better than hedge funds because their funding is not as fragile.  So yes, Mike, hedge funds will be needed to fill the gap left by the exit of prop trading banks, but they won’t be there precisely when needed.  Things will work just swell.
  5. Gazprom was named the most opaque corporation in the world.  I am shocked and stunned.  It is allegedly the most profitable.  Again, no surprise: government enforced monopoly is a nice gig.  But the company has been forced to make price concessions on contracts to big customers.  It is fighting a rearguard action against the flood of gas being discovered around the world.  It won’t happen overnight, but government mandated monopoly or no, the company’s future is not bright.
  6. The to-ing and fro-ing over privatization in Russia continues.  Putin allegedly threw a spanner into Sechin’s ambitions to acquire “privatized” assets, including electricity generators.  But his words are pretty weak: “That does not mean we should limit ourselves to participation by Rosneftegaz.”  So you could envision some competitors in the bidding process, and them prevailing enough times to give the impression that a real privatization is going on.  But this is likely to be a Potemkin privatization, and Sechin et al are likely to prevail.  Sechin certainly thinks so: “Russia’s most influential energy official, Igor Sechin, said on Tuesday the state-owned energy holding Rosneftegaz was given permission to invest cash on its balance sheet in comments which seem to contradict assertions by a top government official [Akardy Dvorkovich].” I would bet on Sechin.  Hands down.
  7. There is a spate of bad news about the weakness in China’s economy.  I have been a China bear for going on three years, or more actually.  The first reason for my pessimism has always been China’s ramshackle and rigged financial and banking systems: this predates the crisis.  This post provides an excellent overview of the reasons to find that system “scary.” Yes, the Chinese government has papered over past problems, but there are limits to this, as there are to all things.  Indeed, as the economy has gotten larger, and in the aftermath of the crisis and the massive monetary and fiscal response thereto, the state’s capacity to continue to do this is very questionable.  The second reason is that, contra Tom Friedman or Ray LaHood, I adamantly do not believe that the allocation of capital by the state, directly, and indirectly through financial repression and a hugely distorted banking system, will end well.  In fact, I believe the exact opposite is true.  Suppressing price signals and allocating capital to cronies and state owned enterprises is a recipe for grotesque misallocations of capital.  In the short to medium term, it can lead to impressive GDP numbers.  But spending insane amounts on investment eventually leads to catastrophe if that investment doesn’t produce returns.  That, in a nutshell, is what China looks like to me.  And these two sources of pessimism feed off one another: when the investments don’t generate returns, and in fact generate losses, the banks and trust companies and insurance companies and whatever that provided the finance are toast.  When you force feed a goose, you can at least get good liver pate (but not in California!).  When you force feed investment, eventually you get a bust.

That’s all for now folks.  Catch you again soon. Promise.

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  1. Gazprom was named the most opaque corporation in the world.

    A few months back they were named the second most corrupt oil and gas company in the world. They were beaten into first place by the Nigerian National Petroleum Company.

    Also, I’m surprised you didn’t comment on the Krasnodar floods, the aftermath of which – according to the couple from Krasnodar who I had dinner last night – is full of the usual obfuscation and finger pointing by the authorities coupled with grand but utterly pointless promises from the Kremlin, and with the death toll being an order of magnitude higher than what they’re saying it is. Looks as though disaster season has come early in Russia this year.

    Comment by Tim Newman — July 10, 2012 @ 11:24 pm

  2. We will NEVER reform financial markets until we reform the regulators. We will NEVER reform the regulators until there is a crisis sufficient for the people to demand reform and for one individual to emerge as the leader of that movement. A thousand voices, all promoting private interests that perpetuate the status quo and coalesce around unenforceable regulatory pronouncements will always drown out the voices of those championing the common good.

    The most disillusioning moment of my career was in 1995 and was my first day working on Wall Street after working in banking and trading for 10 years in L.A. And Chicago. I realized at that moment high paying positions in the financial services industry weren’t part of a meritocracy, but rather of a kleptocracy. Financial professionals from 25 to 50 have it ingrained in their DNA that regulators are incompetent, that financial crime pays and when in doubt, go for it. Financial crime pays bacause financial crime pays, even in risk adjusted terms. I can tell of an ongoing financial fraud going on at this moment that involves over $100 million of stolen investor money. I have tried to bring it to the attention of regulators and they simply don’t care.

    Changing the perceptions of financial insiders that financial crime is worth running the risk of being caught by incompetent will take decades. We won’t see it in our careers. Too many industry professionals see too much going on around then and nothing being done to think honest, hard work is the way to go. Sad, but true.

    Comment by Charles — July 11, 2012 @ 9:06 am

  3. Professor, two interesting things took place in UK/EU and USA in the last couple of days along the lines of the implications of regulatory overreach. Thought you might find to be of interest:


    Comment by MJ — July 11, 2012 @ 10:16 am

  4. @Charles . . . I guess that implies we will never reform the financial markets. Amazing what you relate re $100 mm ongoing fraud. Depressing, but amazing.

    The ProfessorComment by The Professor — July 11, 2012 @ 5:54 pm

  5. “I guess that implies we will never reform the financial markets” = As dictator Lukashenka once put it, “Belarussians are going to live poorly, but not for long”.

    Comment by Ivan — July 12, 2012 @ 12:47 pm

  6. @Prof –

    Want me to share the list of former Stanford senior managers who were let off the hook by the SEC and FINRA, allowed to continue with clean records and have been sued by new clients for securities related “malfeasance?” It isn’t lost on industry professionals that the SEC and FINRA do not want to be bothered with violations of rules and regulations. Regulators want to put in their time, earn their pensions and retire ASAP to get hired at triple their former salaries by the firms they were “supposedly” regulating.

    Stanford had Bernie Young (NASD enforcement lifer) Spencer Barash (SEC enforcement lifer), Thomas Sjoblum (SEC enforcement lifer) and Jim Conzelman (former Chief of Staff for Michael Oxley – yes, of Sarbanes-Oxley Fame) on his payroll to keep the feds away. Not a single Stanford or Madoff employee has been sanctioned in any way by FINRA. Mary Schapiro was running FINRA while Madoff and Stanford were running wild and she got moved up to head of SEC (with a 8 figure exit package from FINRA). Mark Schonfeld and Wayne Carlin were Directors at the SEC office in NYC while Madoff ran wild and both of them received raises in the range of $2 mil/ yr after the scandal blew up, their failure to expose Madoff was exposed and they left the SEC for the “other side.” Timmy Geithner is just counting the days till he can leave the administration, join Goldman and get the multi-million dollar payback he has earned for not regulating Goldman.

    In other words, no, we will never reform the financial markets. Not in our lifetimes.

    Comment by Charles — July 12, 2012 @ 3:36 pm

  7. Excellent stuff and technically excellent in terms of knowledge. Keep it coming. I am blogging you quite a lot!!!

    Comment by Bertie B. — July 20, 2012 @ 3:37 am

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