DAMN PAUL!

No, not that Paul of recent writings but another Paul, another of my really smart friends who just ruined my day. You see, I was just finishing up today's edition feeling rather good about myself when he rang up

"You know," sez he, "I think you're only getting half the picture. It's worse than you think."

"That so," sez me.

He then proceeds to explain where I'm way off base in yesterday's posting. We battle. We agree I'm not way off base but I did a lousy job of explaining what went on that it sure makes me appear way off base.

I have now scrapped today's posting and am trying to regain some credibility in a re-working of the world of derivatives. I knew what I meant to say but didn't say it very well. So thanks, Paul, so bloody much. See you tomorrow.

DUSTOFF 26

During the early days of Vietnam there was a certain HUEY pilot whose call sign was DUSTOFF 26. He flew Med Evac and as there weren't a lot of troops committed at the time, his call sign was often heard whenever an evacuation was needed. Over the course of the war, the call sign stuck; every med evac flight became know as a DUSTOFF. They saved a lot of guys at considerable cost to themselves so I thought from here on out, our Fed Chairman will no longer be known as Helicopter Ben but in honor of those brave guys we shall call him DUSTOFF.

DUSTOFF showed up on the Hill today in front of Barney and the boys. Yak Yak, Blah Blah. Things better but not great no change coming. Really a non-event. Hardly any talk about the governing legislation for the financial industry that is swirling about both the Senate and the House. I thought for sure one of those geniuses was going to ask him about derivatives in light of Arthur,Arthur's article of the other day (thank you Paul, for pointing out that Arthur, Arthur is conflicted seven ways to Sunday) but it never happened. Thank heavens for small favors

Anyway, to continue from our conclusion on Monday, there remains still a good deal of confusion as to the role derivatives played in the crisis primarily, I think, because the term is being used in connection with what happened with AIG with the focus being almost entirely on AIG. I suppose one could say that the instruments created by AIG which are the focus of all the conversation are technically derivatives but in fact they are really somewhat esoteric insurance policies not unlike, in their purpose, forms of guarantees that have been used by financiers since some Medici back in 14-something wrote a guarantee or a special purpose letter of credit in favor of Da Vinci completing some work for a buddy in Firenze. They have been around for years. Of course the quants on the street had to get fancy and support the creation of the same with all sorts of formulae to explain the risk profile allowing other quants to price the damn things so that a market could be made in them forgetting, of course, that none of this brain power was worth a crap if nobody wanted to buy them which, in the terms of the market is stated there being no bid. But, before these things got sliced and diced it was a series of fairly straightforward transactions between risk-takers and hedgers of risk with a finite number involved. No method of transparency would have improved upon the situation. Please keep in mind that underneath all of the underwriting done by AIG there should have been an asset: in other words if one were to call on the guarantee that which was the object of the guarantee would have to be delivered--sort of a "no tickee, no washee," as we used to say in the good old days before PC. But AIG, MBIA and the other geniuses who wrote this stuff were so sure of their math that they allowed their contracts to include the ability of the purchasers to require additional collateral if either the perceived credit of the underlying risk or its guarantor deteriorated. In short, they screwed themselves. And now, Houston, we had a problem. Irrespective of ownership of the underlying assets the guarantors were now required to pay up to the counterparties without an off-setting return of the guaranteed assets. With all respect to Arthur, Arthur, the problem was not transparency but plain ol' stupidity on the part of the underwriters. Hubris kills you every time in the end. That's not to say exchanges aren't a good idea; it's not to say more transparency is bad but it is to say that if you are arrogant and stupid and get into a business you know little about while suffering from all of the above you will probably get killed despite being as transparent as you can be. I'm all for improvement but let's first understand what happened and why before we go racing out to solve the unsolvable. Bold statement: This was a failure of market understanding and of management. We will never know but if the board of AIG had not been cowed by the dreadful Spitzer and fired Hank Greenberg this would not have happened. Government intrusion into business for the purpose of personal political gain. This is the result.

APOLOGIES

Going to have to skip a day. In the midst of trying to organize a campaign committee to help a friend run for county assessor. Deadline approaches. Back tomorrow

ARTHUR, ARTHUR

Right on cue, as though by magic, just when I was going to start putting down some thoughts about managing banks Arthur Levitt comes through with an op ed piece entitled Risk and Discipline in the Financial Markets in the Wall Street Journal today. Do you think Arthur is a reader of the blog? One wonders. Anyway, at one time you might remember that Mr. Levitt was the Chairman of the SEC (1993-2001) and now he is an advisor to Goldman Sachs, and not an unpaid one I am sure. Mr. Levitt served at the same time and in the same administration as Robert Rubin and both men at the time enjoyed extremely high reputations among their peers for reasons, quite frankly, which escaped me. One might remember that Mr Levitt oversaw the Great Dot Com. Boom...and bust...during which 16 year old analysts at the great Wall Street houses were pumping companies' stock prices into the stratosphere on the basis of...well, on basically no basis. Nevertheless, comes now Mr Levitt to explain to us, the Great Unwashed, how we can fix things going forward. (Full disclosure: I have no reason to be upset at Mr. Levitt. I put two kids through college buying and--fortunately selling--crap just in time). My future turned out not to be so bright, however.

Mr Levitt has focused on derivatives as being the cause of all sin in the world and especially unregulated derivatives traded OTC. Before that, however, Mr. Levitt concludes that we must eliminate the risk of Too Big to Fail hereinafter referred to as, "TBTF" in every instance in the future), and with that the related Too Interconnected To Fail" (TITF") which he attributes solely to an institution's involvement in unregulated and non-transparent derivatives markets. He correctly points out that there are in place unique protections for derivatives that complicate the winding up of a financial institution but to hold as he does that the solution is to standardize the creation and trading of instruments would solve the problem is naive to a fault. Mr. Levitt argues that institutions will gravitate to those marketplaces that offer the best protection against systemic risk: crap. I simply do not believe that any consideration of systemic risk enters into a trading decision on the part of any institution in the world. Systemic risk does not exist as a relevant concept until it occurs. Remember my definition? It is when everybody gets the crap scared out of them at the same time. Credit risk for individual institutions, yes. But systemic risk? That boys and girls is a concept best left to central banks to prevent and that NEVER can be done through regulation. It exists in the air, not on the ground and is created through the convergence of a series of factors, sometimes preventable but often not foreseeable until the very last moment. This is very hairy-fairy stuff and I want to get all my thoughts in order so we will follow up tomorrow. Stay with me.



Loyal reader Paul commented on the rise in the discount rate the other day by remarking that the rise was hardly enough. Paul, don't sweat the small stuff. If nobody is using the window what the hell difference does it make what the rate is? It was a meaningless gesture designed to test the reaction of the market. The Market reacted to the meaningless gesture as it always does; it ignored it. You should too. But thank you for reading and for your comments

THOUGHTS FOR THE WEEKEND

Despite the fact that our guy can't do a quadruple Sowchow, toe loop or tonguestand, my wife tells me we won men's (?) figure skating and the Russians are pissed because their guy can jump. When does the baseball season start? I can't take much more.

Anyway, yesterday just before the sun set, the Fed raised the discount rate, you know, the rate at which banks can borrow from the Fed's discount window which usually occurs only when all other sources of funding are unavailable. Now the Fed never does this at the end of the trading day and rarely does it in the middle of a cycle, so why yesterday afternoon? The only answer I can come up with is that this Fed, forever attuned to the politics around them was afraid that any action of this nature might roil the markets in a very sensitive period. Or, to put it in a somewhat more skeptical light, somebody on the street just might get the bright idea that this stock market recovery is entirely the result of a sea of liquidity and run for the exit at the slightest sign of tightening. Memo to Ben: didn't happen. Just try to do your job please.

Now that's not to say that there is real joy in the recovery theater. There isn't. Markets are still liquidity driven, but when you have a gazillion dollars of excess reserves sloshing around in the Reserve banks, liquidity is not an issue. These guys are even making money on this stuff now. So what happens next?

The boys in the coffee shop here in the fly-over zone still don't like what they see and we all remain a touch concerned when the main street banks start trying to collect on the construction loans and the commercial real estate that's out there. As the Sage of 161st and River Ave. put it, "It ain's over til it's over," and I don't think it's over. Just something to think about over the weekend. By the by, if anybody knows what the hell is the difference between a Sowchow and a Lutz, let me know will you?

Governance and Risk next week.

ABOVE THE FOLD

The positioning of a news story is usually a good indicator as to its importance. With respect to the New York Time"Above The Fold" always indicated that the story was important(the paper being folded in the middle for newsstand presentation). less known is what the positioning as to the right or left above the fold means with everybody knowing that right column, above the fold is reserved for THE story of the day...but the left? Ah, that's an important story but over the years regular readers have figured out that the Times didn't have to work quite as hard for that one. That position is usual a spot for an important leak; a tale the pols want run up the flag pole to see who salutes. So it was today.

The Times released a story indicating that the administration had reached the decision that it would be the Treasury that would be the overseer of systemic risk...or something like that. What was suggested that the Secretary of the Treasury would chair the effort with the Chairman of the Federal Reserve serving as vice-chair. What that means of course is anybody's guess but that's about as far as the discussion got. Interesting enough, what was NOT said was that there was broad, general agreement to this policy decision either within the administration or within Congress...or at least that's the way I read it.

Now we all know that Helicopter Ben had pretty much caved on everything to insure his re-confirmation but what is less widely know is that there has been a hell of a push-back not only in the D.C. Fed but in the reserve banks as well. And rightfully so I might add. On top of this it is the systemic risk issue that has gotten everyone's knickers in a twist around the world (although no one has a better handle on what they are talking about than we do) but that is coupled with a concern that Uncle hasn't really gotten its act together especially on the political level. Nobody wants to deal with this Treasury which is generally considered to be disorganized and in some areas quite inept. On a issue such as this where a full and in depth understanding of all things international, not the least of which is the payments system, few consider the Treasury to be the peer of the Fed. But as is becoming more and more clear, everything in this administration is political and to a great extent everything is being run by the policy boys who in matters such as this are precisely the people you DON'T want running things.

I've said before that I haven't a clue what is a systemic risk institution except that it undoubtably one that is BIG in size and BIG in functions. It is one that is too big to fail but as Volker the Great has put it if you're too big to fail, you're too big. Consequently, at some point somebody is going to come to reach the startling conclusion that everybody is talking in circles and the answer is not in the appointment of some mess of poor schnooks who are given all the responsibility but none of the authority to prevent what is probably unpreventable by those not endowed with the foresight and wisdom of the Deity and to focus more clearly on governance of the institutions themselves for as much as we may hate to admit it I suspect we have reached to point--for a variety of reasons--where regulation and regulatory infrastructure have reached their limits. More on that in the days to come.

AWWWWWWWWWW!

Damn Germans. They have no sense of humor whatsoever. I though we were going to have some real fun with this Greek thing but the Germans just folded and gave the Greeks another month to set things right. Yeah, fat chance. Now kicking the can down the road IS a strategy but at some point the Euros will have to come to grip with the problem and we'll be there.

It's remarkable just how much ill feeling towards the Greeks specifically and the the entire concept of the EU in general has arisen as a result of this affair, especially in Germany whose citizens believe--rightly or wrongly--that they are going to bear the full burden of any bail-out. There is an element of "i told you so" among the population for it was always the fear that absent true political integration it would fall to Germany to bare the full cost, whatever that might be of the EU. The thought of bringing a group of diverse nations whose common goal for the last 900 years has been to kill off their neighbors into some form of truly integrated political entity was, for some of us at least, a bridge way too far for starters. Odd how politicians seem to believe they understand their people better than the people themselves. We're going through a bit of that thought process in our country today where The Leader's vision for the United States doesn't quite match that of its citizens irrespective of how the last election turned out. We shall see how all this plays out on both continents. In the mean time, it's tough on we bloggers in the face of the patience of Jobe being shown by the Euros. In the meantime, I think I'll stay off Airbuses. If it aint Boeing, I aint goin." Or so say my pilot buddies.

We're going to get back to the banking business tomorrow. Sorry, I wasn't ready for this flop of today. Oh, today marks the 400th hour when the temperature hasn't gotten above freezing. I wish Al Gore would come back.

DON'T BLAME ME!

Blame George Bush. Hell, I don't know why the Euros didn't do a deal over the weekend with the Greeks. Because nobody wants to? Could be. As Paul commented, "It's Greece, who cares?" Aside from the bond holders I suspect that there are a few hundred members of the European Parliament in Brussels earning a couple of hundred thousand Euros a year for doing sweet fanny adam care even though in the best of weather Brussels is a God-awful town even when the trains don't run into one another but in the winter it's unlivable. Good Grub, though. Sensational if the truth be known but only if you like butter and cream like me.

I suspect it just hasn't gotten bad enough yet. It will, rest assured. Carter asked, "Who's next?" and to be honest, I hadn't thought about it. I guess the felling over there is let's not have a next one, let's try to end it with the Greeks but to an extent it's sort of like putting the toothpaste back in the tube; the problem has been exposed and a lot depends upon how much international co-operation is present. One thing you might keep a eye on, however, is how this mess over there is affecting things over here. Last Wednesday, we had a perfectly stinking auction of $16billion worth of long bonds Primary dealers were forced to take down almost 50% of the issue. Now I recognize with the economic conditions being what they are all around the world, 30 year bonds should not be expected to be the smell of the week but this auction was bad with a capital B. I keep going back to the point I've been trying to make over and over; this business is ll about trust and perception. It really doesn't make a difference what the reality of, say, Spain's finances might be. If the perception is Spain's finances stink, they stink. In today's world, Greece affects Spain, Spain affects Portugal, Portugal affects God knows who and they all affect us...at some point, even if it means nothing more than paying up for a 30 year issue.

As to this little Euro mis-understanding, there was a tiny miracle today in the New York Times. Paul Krugman actually got it right and wrote something that actually made sense. Seems as though he's cottoned on to the fact that when your fiscal policy originates in Athens but your monetary policy is set about 1000 miles away you may have a problem. He also thinks that political union may not be a bad thing to go along with monetary union but that might be hard to come by. Way to go Paulie, Bay-bee! Some of us had that germ of an idea some 20 years ago but welcome to the party. Wonder way he's saying this now when his guy is in deep do-do? Maybe I'm too suspicious, oh well. Anyway, Carter, my loyal reader, the real answer to your question may not be Spain, Italy, Portugal or any of the usual suspects. The real answer may be the EU itself, as impossible or unreal as that may seem. It's a good story. We'll be watching it this week.

FIRST YOU SAY YOU WILL, THEN YOU WONT...

THEN YOU SAY YOU DO AND THEN YOU DON'T... Rather racy lyrics for their time and so fitting for today's headlines. First, the Greeks had a deal...then they didn't...then they had agreement...but no terms discussed...it was a guarantee...no,it was...Ah forget it. Translation; methinks the Germans agreed that they would save Euroland as we know it but nobody like the terms they were discussing. So everybody goes home to figure out how to eat humble pie and the talking heads can remain all atwitter not really having a clue at what is going on.

I still think it's going to be some form of guarantee but another way to do it is simply throw a bid in under any new Greek refinancing which will, for the professional underwriters at least, supply them with known distribution whilst maintaining the fiction that the Greeks were able to refinance themselves. Sovereigns like that. To be seen being bailed out by another country--especially one by whom you were occupied well within human memory is not good for the political spirit. In the mean time the government is making all the right noises as to fiscal policy and the unions are going nuts which is always a good sign. In the end, there is always the threat of the cursed IMF getting involved and NOBODY wants that I suspect unless all the players have lost their reason. Anyway, it now seems certain that a deal will be done so at this point what sort of a deal it is is really no more than of academic interest.

More interesting is the possible knock-on effect or as we like to say in the trade, will there be "contagion" among the other players in the region to wit, Spain, Portugal and Italy? Could be. If Greece gets a good deal, why not me? Know what I mean, mate? That remains to be seen. Spain and Italy are REAL countries as opposed to Greece which is only a real country. Of course, Italy has been playing this game since Julius Caesar was a corporal but we shall have to wait and see. What the heck, Al Gore is lost, the country is frozen solid and there's nothing to do in the mid west til' March Madness. There is one thing to think about, however, that I find fascinating. The Euro

The conventional wisdom is that whatever happens the result is not going to be good for the Euro. That's probably correct. So my favorite question arises, Cui Bono...who benefits? Obviously, the first thing that comes to mind is the dollar. That's every-bodies' trade as the Euro has fallen--nay, dropped like a rock---from over 1.60 to 1.37 almost overnight. USA! USA! Ah, just hold on a minute. Remember what The Leader blurted out during the State of the Union? We're going to triple exports to put our house back in order (I wonder why he didn't say TEN times over, it's equally stupid and sounds better)? Not with the Euro around 1.20 we're not or anything like that. In fact we will probably get our butt kicked all around the globe beginning with...think about it...still thinking...you got it! Germany. So I said to myself, Self, ol' Fritz just might come out of this one smelling like a rose. Their enormous export engine which just lost first place to the Yellow Horde now powered by a more than competitive currency while the Yuan is locked to a rising dollar? You could sell tickets to watch that one. 'Of course I'm making it sound simple (haven't spoken with my smart buddy Larry yet) but this thing has more implications to it that you read about in the paper. And you heard it here first. As for The Leader and his band of merry men...YOU'RE UNDECIDED NOW SO WADDA YA GONNA DO?

More tomorrow. I'm having fun with this.

...LET THE LAST MAN ON THE RIGHT

...BRUSH THE CHANNEL WITH HIS SLEEVE! It wasn't a bad strategy developed by Von Rundstetd the Elder that actually worked in two wars...well, almost. First time round they got hung up on a river but could see the lights of Paris and the second time...well, the little guy got into a spat with the Ruskies, the Brits got all stroppy and stalled the whole thing, then he decided to take on the Yanks and the rest is history. This time they might actually grab the golden ring.

No, I don't mean young Fritz is going into the closet to dress up in grandpa's fetching gray uniform. But it is becoming more apparent that the whole world is looking to the Bundesrepublik to pull the Greek acorns out of the fire and I think they will..for a price.

Let's review the playing field. The Greeks owe about E300 billion (about $420) at current exchange rates. Most of it is foreign held and most of it in bonds. BIS reporting banks say the hold about 25%; the rest? It would be nice to know but it isn't and that's not a good sign. Now I for one would love to see the Euros say the hell with you go work it out but that isn't going to happen unless something really goes haywire. A Greek default might very well signal the end of Maastrict and would certainly, in my estimation destroy the Euro as a serious currency so that's not going to happen. Too much a stake. Greece has highlighted what everyone knew was the problem; monetary policy, created in a void of local political reality meeting the lack of fiscal discipline. A train wreck in the making. Bound to happen. But is allowed to default one can be certain that those other countries close to the brink will say, "Bugger this monetary union stuff," and start doing what they gotta do by beginning to print their own money once again. EU=RIP.

So what happens? As mentioned, not knowing who are the creditors makes things a bit more difficult. Way back when, when only banks were the lenders of record, life was easy. The central bankers of the world grabbed all the banks, put them in a room and beat their brains in until they halted collection attempts and then rescheduled the debt. Easy. Not so with bond holder. The reason? No leverage. Not to change the subject, think of AIG for a minute and perhaps the reason for the inability to negotiate a haircut from the beneficiaries of the CDSs becomes apparent. If you think the world is going to end in ten minutes and the other guy KNOWS you think that, waddya got? What you don't got is leverage, Jack. The banks involved are probably going to be asked to reschedule whatever they have in some ugly way...and they will. In return, they will probably get a guarantee of principle (but not of interest--some risk must be taken,what?) The bond holders who will of course come out of the woodwork are going to get asked to give up something; whether they do or not is an open question. As for the guarantee?
It will be German-led but involve all the usual players in Euroland. And in return? Ah, mein leiber freund, more about that tomorrow as well as the issue of moral hazard. Any thoughts?

BEWARE OF GREEKS...

Well, we're back. The eulogy went well but in the time we were on Long island I lost a cousin and another dear friend who was exactly my age. Things come in threes so I guess I'm safe for a while. But when the Big Trader decides to lift your bid...anyway you can't worry about it.

What one can worry about is Greece. The Greeks owe a hell of a lot of people a hell of a lot of money and have to borrow nearly $40 billion in the next few months just to keen the loans rolling (remember, a rolling loan gathers no loss). It anit out there, at least not yet from the usual sources. Now Greece is no Iceland; it is a real country and the consequences of a default are more than a touch dire for the Euro Zone, Euro Banks and the entire fabric of the European Union. The Greeks are also a bit nuts...at least in my experience. One is never quite sure which Greek you are going to get when one wakes up in the morning. Consequently, there is more than a tiny chance that something could fly off the rails before this is over--not that I'm making a prediction but the chance is there.

Now I must admit prior to may absence, I was going to explore who holds the Greek debt and in what form as the answer to those questions will go a long way in determining how this rescue package is to proceed. late this afternoon, the Journal announced that the sing on the Greek Central bank was about to have added, "Deutsche Bundesbank, Prop." but that has yet to be confirmed. I can't imagine any of the governments going it alone on this one--or even in concert--without exploring the well-known concept of "burden sharing" on the part of commercial creditors but until we know the size and stock of the debt how this could be structured cannot be know. That's my job for tomorrow. Anyway, our stock market took heart and rallied so maybe somebody knows more than I do...which wouldn't be the first time. Most remarkable, however, is the fact that the Greeks were lying through their teeth as to the state of their finances FOR YEARS and neither the EU, the Fund or anyone else who should have cared picked it up. Of course, my really smart friend Larry has been blowing the whistle on this for a couple of years now but nobody listened. Waiting in the wings of course are Portugal, Ireland, Italy and Spain so how this is dealt with is of no little consequence. Things are changing overnight so we'll pick up this tale tomorrow.

Nice to be back.

ON THE ROAD AGAIN

APO
LOGIES. I'M HEADING EAST TO GIVE THE EULOGY AT THE MEMORIAL SERVICE FOR MY FRIEND JOE. I'M NOT INTO WRITING MUCH ELSE. NOT A ADULT REACTION, PERHAPS, BUT IT IS WHAT IT IS OR TO BE MORE ACCURATE, I YAM WHAT I YAM

SEE YOU NEXT WEEK