Business
Ted Kaufman: Big Bank Time Bomb Ticking
Haven’t we had this discussion before?
And maybe I said “I told you so” then? Forgive me. But we still haven’t gotten to the point where we actually do something about federally insured big banks gambling with derivatives.
Investopedia defines a derivative:
… a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.
Got that? I prefer Warren Buffett’s more succinct definition: “I view derivatives as time bombs, both for the parties that deal in them and the economic system; derivatives are financial weapons of mass destruction.”
Certainly Buffett’s definition better explains the news report that JPMorgan Chase, the nation’s largest and most profitable bank, confirmed on May 10 that it had suffered a $ 2 billion loss on credit derivative bets, mainly by a trader colorfully named the “London Whale” in its Chief Investment Office. This was less than a month after Chase CEO Jamie Dimon had branded a Bloomberg News report that there was a major problem with derivatives in his London Office as “a complete tempest in a tea pot.” After the announcement of the gigantic loss, Dimon said, “in hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored.”
Uh-huh. And haven’t we heard that before? This was just the latest example of the high profile financial disasters caused by the use and promotion of derivatives. Remember when the very prosperous Orange County of California decided to dabble in derivatives and ended up in bankruptcy in 1994? Or when a derivatives trader at Barings, the oldest merchant bank in London, ran up $ 1.3 billion in losses in 1995 and put the 200-year-old firm out of business? And of course you remember when Long Term Capital Management had to be bailed out by the Federal Reserve in 1998 after $ 3.5 billion in bad derivative bets.
I could easily cite others, but let’s jump to 2008 when derivatives hit the really big time and were complicit in the failures of Bear Stearns, Lehman Brothers and AIG, claimed their first country — Iceland — as a victim, and very nearly brought down all of the world’s financial markets.
Derivatives are involved in the present Greek economic crisis, a crisis that once again threatens the world’s economy. Last February, German Chancellor Angela Merkel talked about the use of credit default swap derivatives by the Greek government to hide its deteriorating economic situation from the rest of the Eurozone. “Credit-default swaps,” she said, “where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb.” “Surely,” said former Fed chair Paul Volcker, “the recent revelations about the use (and abuse) of complex derivatives in obscuring the extent of Greek financial obligations reinforces the need for greater transparency and less complexity.”
That’s exactly right. No one is calling for a ban on derivatives trading. Even Warren Buffett’s companies use derivatives. They have legitimate uses in risk management. What is so abundantly clear is that the lack of transparency in derivatives trading, and the sheer complexity that is a by-product of that lack of transparency, really can make them “financial weapons of mass destruction.”
Volcker, of course, is the author of the Volcker Rule in the 2010 Dodd Frank Wall Street Reform Act, which would restrict trading by federally insured banks for their own accounts, called proprietary trading. But the Dodd Frank legislation, now 22 months old, kicked the can down the road to regulatory agencies on hundreds of issues involving its implementation. And, as always, the devil is in the details.G iven the intensity of Wall Street lobbying to stop regulation, it is no surprise that rules are being postponed. A September 2011 study by Duke Law School professor Kimberly Krawiec found that 93 percent of the meetings with the regulatory agencies responsible for implementing the Volcker Rule were with representatives of financial institutions. If anything, that percentage has become higher since last September. Want to bet on a really effective interpretation of the Volcker Rule?
Here’s a depressingly ironic coincidence: On the same day JPMorgan Chase announced its derivatives loss, the Commodities Future Trading Commission announced that, after almost two years of study, it was going to have to postpone a decision on derivatives until Dec. 31, 2012.
Believe me. I’m not looking forward to my next “I told you so” column.
Ted Kaufman is a former U.S. Senator from Delaware. Please visit www.tedkaufman.com for more information. This piece first appeared in the Wilmington News Journal.
From:The Blog
Nancy K. Humphreys: The NBA Pass: When Monopoly Met Oligopoly
My post, “The Apple Conundrum,” showed what can happen when monopoly and oligopoly are in conflict with each other. But what happens when the two get together to sell a product?
Oligopoly pricing of necessary goods
Most Americans realize oil prices have very little to do with supply and demand. The oil industry is controlled by oligopolies. These “cartels” control the price of oil and gas. Gasoline is largely an inelastic good, meaning most Americans can’t get by without it. So the price of gas is easily influenced by both OPEC and by large domestic refiners of gasoline in the U.S.
But what about products that are not a vital necessity? Could prices of elastic goods be legally fixed by a small cartel of big retail companies working with a monopoly? You bet! Let’s look at an example.
Monopoly/oligopoly pricing of luxury goods
During the regular basketball season, the NBA Pass costs a bit under $ 200 to see all of the games in the U.S. A slightly less expensive version allows you to follow all the games of your five favorite teams.
Wiki.answers.com says “there is no official number, but probably around millions” of NBA fans exist. You can be sure that $ 200 per fan is pretty important to both the NBA and the broadcast companies that get a piece of that fee.
The National Basketball Association (NBA) is a trade association similar to OPEC. Unlike OPEC, the NBA can set a monopoly price because, as it reminds viewers before each game, it owns the exclusive “intellectual property rights,” i.e., the copyright, to all of the broadcasts of games played by teams that belong to the Association. Federal law and the courts protect the NBA’s right to fix the price.
You know the NBA Pass is monopoly-priced because all telecommunications services in the U.S. offer the NBA Pass for the same fee. Pay it, and the ardent fan can watch games on TV, a mobile device, or their computer. That’s great!
What’s wrong with monopoly/oligopoly pricing?
What’s bad about the NBA Pass? The whole point of cable/satellite media was to open up the market for telecommunications broadcasts from outside one’s local viewing area. This is exactly what the NBA Pass is curtailing.
You may not be able to find basketball games you want to see because the NBA Pass exists. I can’t speak for all the services offering this Pass, but here is what the DirectTV package I have does to get its customers to buy the NBA Pass.
In its search directory for TV programs, DirectTV only lists its NBA Pass stations. During the regular season, DirectTV doesn’t list basketball games on TNT, ESPN, or NBA TV, three stations included for free in most cable packages.
Finding a basketball game in a haystack
Why would DirectTV do this? Oligopolies are not as free as monopolies to gouge customers on price. The NBA can set an exact price for its exclusive Pass each month, but not so the broadcast companies. Media customers can, and often do, switch from one provider, or from one kind of media to another. Telecommunications companies themselves foster this kind of behavior by offering low prices to new customers.
For this reason, DirectTV can’t and doesn’t force viewers to buy an NBA Pass. It simply makes most of the basketball games offered via stations included in its cable packages invisible in its program directory.
By accident I discovered that if a non-Pass-holder is on an NBA Pass station as a game begins, DirectTV might search for a free cable station that also offers the same game. But, if you want to pre-record a game or make sure it’s on, you’ll need to go to the Internet, get your team’s schedule, then scroll through DirectTV’s channel guide for the scheduled times of each game you want to see.
Think this is a trivial issue? Get your wallets ready, sports fans. Your $ 199 NFL (National Football League) Sunday Pass is coming this summer! What’s next? Golf? The Olympics? Baseball?
From:The Blog
David Paul: Why Are Our Political Leaders Jumping to Jamie Dimon’s Defense?
As I write this, Bruno Iksil is still riding the Bongo Board. We have all done it, at least those of us of a certain age. We got up on the Bongo Board and we thought we could stay up forever.
One can only imagine the endorphins pumping across the world’s trading desks. The king of the hill, JPMorgan, has seen its killer trade — reputed to entail multiple hundreds of billions of credit default swap notional amount — go the wrong way, and now they need to reverse out of their position before the stink gets worse. The loss of two billion dollars announced a week ago grew by a billion in a week, and clearly the fire sale is not over.
Faced with a public relations fiasco, Jamie Dimon let his long-time, trusted lieutenant, Ina Drew, take the fall. Meanwhile, Iksil — the trader that amassed the positions that have been a topic online since early April — cannot be let go because he is the one that understands the billions and billions of complex derivative contracts that now need to be unwound. It must be quite a spectacle on derivatives trading desks around the world. It is get-back time, and in that world no one takes any prisoners.
As the hedge funds continue to circle in the water, feeding off of JPMorgan’s exposed balance sheet, Dimon’s friends on Capitol Hill have been quick to come to his defense. House Financial Services Committee Chairman Spencer Bachus (R-AL) was quick to minimize the importance of one loss, whatever its size, while across the aisle President Obama lauded Dimon‘s bona fides and JPMorgan as “one of the best-managed banks there is.”
Politicians jumping to Jamie Dimon’s defense are missing the point. This is not about a single trade or one loss. Iksil, whose nicknames “Voldemort” and the “White Whale” (think Ahab’s nemesis, not a fat Frenchman) should give a hint as to his industry reputation, and now that the hedge funds have tasted blood JP cannot get out until the counterparties are good and ready. That the loss is still growing simply means that they are not ready to let go.
But if JP’s counterparties have Bruno by the balls, so too does Dimon have a firm grip on the nation’s political leadership. Last week on Meet the Press, Jamie Dimon described himself as still a Democrat, but just barely. Once a prominent Obama supporter, Dimon is one of many across the finance community who feel that they have been unfairly tarred for cratering the global economy.
To put a finer point on it, despite the media feeding frenzy surrounding Voldemort’s personal Black Swan event (Nicholas Taleeb’s now-famous phrase for things that can’t go wrong, until they do) comments from our nation’s capital remain measured, almost fawning. Democrats and Republicans have fallen over each other to praise Dimon as America’s Greatest Risk Manager notwithstanding JPMorgan’s contretemps. Dimon’s reputation grew out of the ease with which JPMorgan navigated the financial crisis, though some have suggested that Dimon’s predecessor as CEO, Bill Harrison, deserves a fair share of the credit. Harrison, apparently, minimized the bank’s exposure to exotic mortgage derivatives and handed Dimon a pretty clean balance sheet when Dimon arrived on the scene as CEO in 2006.
While some of the adulation garnered by Dimon may well be warranted, it is likely that most of the politicians uttering the hosannas have no idea what risk management is. It may be that what we are actually watching is a not very subtle food fight between our two political parties for campaign cash. Simply stated, this is not about Dimon’s management skills, rather it is about his wallet.
Over the past two decades, the financial services sector has been the most generous source of political money, and that money has been up for grabs. For decades, the Republican Party was the party of Wall Street. That singular identity ended during the Clinton administration, which was determined to lure Wall Street’s lucre across the aisle. While Clinton and the Democrats grabbed the golden ring, the price for the nation was steep: the Financial Services Modernization Act of 1999 and the ensuing Commodity Futures Modernization Act of 2000 that together laid the groundwork for the financial services world as we know it, and as the world came to experience it in the global financial meltdown of 2008. During the last presidential cycle, according to OpenSecrets.org, the financial sector remained far and away the largest source of political contributions, with 54 percent going to Democrats, while this time around — in the wake of industry anger over Dodd-Frank reforms — the tide has turned and 77 percent of that money is gracing Republican coffers.
Could it be that Chairman Bachus was quick to rise to the defense of JPMorgan because that bank has been the leading source of contributions to his campaigns over the course of his career? Could it be that President Obama is treading lightly on the issue because to date he appears to have lost his edge with two of his largest financial supporters from 2008 — Goldman Sachs and JPMorgan — who according to OpenSecrets.org are the two largest sources of contributions to the Romney campaign?
It is getting boring reading about how the events of the past week — to say nothing of the past decade — suggest why our banks should be smaller or risk trading functions separated from traditional commercial banking. Democrats that continue to believe that we can regulate our way out of this either don’t want to give up their share of the money or simply lack imagination. Banks should be smaller so they can fail with the regularity with which small banks do fail. JP’s oft-repeated argument that their nearly one hundred trillion dollars derivatives book is book-matched and therefore does not constitute a systemic risk to the financial system is disingenuous at best and simply dishonest at worst.
Lost in the endless — and endlessly self-serving — arguments is the fact that commercial banking is essential to the economy, and thus is supported by numerous institutions including the FDIC and the Fed — and that the integration of investment banking and commercial banking (a brainchild of Dimon’s mentor Sandy Weill) has brought little to no demonstrable value to commercial banking’s core societal function, while bringing much to the investment banking world — massive bonuses, a bottomless supply of free capital and the socialization of trading risk.
Both Jamie Dimon and our nation’s political leaders face the same fundamental problem: As risky as the status quo might be, no one can afford to give it up. For Jamie Dimon, derivatives trading is a gravy train that has underpinned JPMorgan’s profitability, regardless of the larger threat it may entail, while for our political leaders major contributors are an irreplaceable constituency always for sale to the highest bidder.
But don’t worry about Bruno Iksil. Whether Jamie Dimon finds he has to let him go, or figures out a way to keep him, he will be fine. There will always be a market for a proven derivatives trader, particularly one with the moniker of the true master of the universe. He will not be tainted by this trade, no matter what the final damage turns out to be, or at least not for long. After all, take a look at his new boss who took over from Ina Drew. He was formerly a trader at Long-term Capital Management.
From:The Blog
Daniel Gulati: The Inexperience Advantage
Ever been shut down by someone who supposedly knows more than you? It happens to me daily. I get denied by people that are more senior, more polished, and more knowledgeable than me. I’d be lying if I said I enjoyed professional rejection, but I try my best to dust myself off and move forward, reminding myself that that a series of controlled failures are necessary for eventual success.
Not surprisingly, I’m not the only one getting ignored because of my inexperience, and the rejections can be downright vicious. Just last week, Kate called me in tears after attending a media conference with well-known industry bigwigs. After spending months anxiously anticipating meeting her professional heroes, she couldn’t have been more disheartened on the day of the event. Noting that she had been working in the industry for less than a year, most executives simply refused to engage in conversation with her, and the ones that did spoke to her in a condescending, suspicious manner that made her “feel like a kid who was inconveniencing a gathering of distinguished adults.” She flew home categorically disillusioned.
As a proud supporter of the young, I was disgusted at the extent to which she was repeatedly shunned for, essentially, being too inexperienced. Yes, young and ambitious people with bright eyes and open hearts need to learn to accept the cold shoulder of established industry gatekeepers, even when it seems like the only goal of the latter is to prevent new ideas and innovation bubbling to the surface of their tired companies and low-growth industries. But a line needs to be drawn between not fully engaging with the inexperienced (painful, but understandable) and making them feel like they’ve committed a crime with their lack of knowledge and years under their belt (not okay, ever).
More importantly, though, I’m disheartened at the response — at how those with limited experience beef up resumes, wear expensive suits, use industry jargon liberally, name-drop awkwardly, and generally try to paper over cracks in an effort to mask inexperience and appeal more to bosses, investors, or interviewers. Why are we playing dancing bear in the circus of the experienced? Everyone knows that you don’t have “deep expertise in retail” when you’re only three years out of grad school. Trying to sound more experienced than you are is a flawed strategy, so you need to change the way you compete.
Instead of forging the impression of experience, I’d rather we turn the tables and use our inexperience as an advantage in the organizations we work for and the companies we start. In other words, we need to start playing to our strengths.
Being inexperienced means you’re not shackled with decades of service in a narrow vertical and the accompanying entrenched biases and relationships. You have natural qualities to offer that companies spend millions of dollars per year in training budgets trying to replicate in their most senior executives. You question long-held assumptions, cross-pollinating your projects with outside ideas. You don’t have to pander to the person who did you a favor all those years ago, and more generally, you don’t have social capital within your organization to protect. This means you’re pretty free from some huge barriers to innovation: sunk costs, self-interest, and bias. That sense of freedom and independence leads you to think that hitting that stretch goal is possible, which makes achieving it more likely. You tend to think of new solutions quickly, refuse to compromise yourself out of existence, and are a native end-user of technologies that could blow existing business models to bits. All this amounts to at least two things: 1) The best organizations should wage wars for people like you, and 2) you can stop looking for opportunities to appear to be adding value. Instead, you can actually add value.
If those nagging self-doubts return, don’t look up to role models for inspiration; look around at your peers for evidence. Writing Passion & Purpose showed me how countless young people have impacted the world in incredible ways, and how they’re doing this in public, private, and nonprofit sectors, across industries, within established organizations and in their own companies. Most importantly, they’re making a difference in industries that they haven’t spent the better part of their lives in. You can join them.
Inexperience doesn’t equal ineptitude, and we need to stop treating young professionals like second-class citizens. To those of you who think that your inexperience is a chronic disadvantage, stop. Don’t let anyone confuse your inexperience in performing a task with an inability to perform it. Instead, be encouraged and seize the opportunity to remain humble, play to your advantages, and show the world you can do better.
This post was originally published on HBR.org.
For more by Daniel Gulati, click here.
For more on emotional intelligence, click here.
From:The Blog
Marc Stoiber: The Key to Successful Eco-Innovation? Timing
I had a great talk the other day about the timing of innovation with Rahul Raj, Director of Sustainability and Merchandising Innovation at Wal-Mart.
We were introduced through colleagues at Sustainable Brands, a conference Raj is speaking at this June. As we’d both attended several SB shows over the years, our chat naturally started with the metamorphosis of CSR reflected in the yearly events.
“I’ve seen sustainability evolve from being a bolt-on risk mitigation tool to something built into the company, to part of a company’s DNA” Raj reflected. “I see the Method model, where CSR is baked into the company charter, as the next step.”
To Raj, the beauty of SB is that you get to meet with companies along the entire continuum of CSR at the show. So no matter if you’re starting out, or have a mature CSR program, there’s always someone there you can learn from or collaborate with.
This talk about the evolution of CSR provided a natural segue to Raj’s speaking topic at SB.
Wal-Mart is unveiling a pilot program in closed-loop retail, which — if successful — would definitely put the company at the leading edge of CSR thinking.
Closed loop is a simple concept with dramatic implications. Our current retail system is set up to sell new products, which are used and then disposed of — very much a linear (and inefficient) process.
Closed loop implies that once products are used and ready to be jettisoned, they can in fact be reconditioned and brought back into the sales loop. This would enable each item to stay in circulation much longer before finally being thrown away.
Wal-Mart has chosen electronics as the area of focus for its closed loop exploration. But the concept works equally well in other retail areas. Raj’s panel partners at SB include Patagonia and eBay — two companies that have partnered to create the common threads clothing exchange.
Closed loop hybrids are also finding success. Concepts like car sharing, for example, are proving the business case for maximizing usage of underutilized products, effectively slowing consumption of new vehicles.
The point is, a few years ago, an innovation like closed loop retail or product sharing would have been laughed off the boardroom table. Timing, it seems, is everything.
“You need to time innovation to the readiness of your market” said Raj. “Wal-Mart was a pioneer in building eco-efficiency and eco-innovation into the business. Each innovation built on the last, and each was laser-focused on our mantra of saving customers money.”
So it seems it isn’t just the consumer who needs to be primed for the release of a new innovation — the company culture needs to be acclimatized to the new thinking as well.
“It’s definitely moving us along a continuum. The exciting part is, it’s helping us as a company stay fresh and innovative, as it helps our society figure out how to survive, and thrive, in a changing world. We’re giving people what they want, in a different way.”
A way that seems perfectly timed, I’d say.
From:The Blog