The Funk Rolls On...

Fifteen years ago a few Wall Street observers vocally became critical of the "off balance sheet" shenanigans of some of, what were called at that time, the "money center" banks.  Further scrutiny would uncover that derivatives trading was growing faster than the normal commercial banking side of the business.  The time would come when derivatives trading would produce a disproportionate percentage of earnings.  When one tried to track down these revenue streams with a magnifying glass, however, many of these transactions were found to be classified in general as "trading" or "other revenue", or sometimes even omitted from the income statements.  The profitability angle was high when leverage worked in favor of the institution.  Losses, however, could be huge.  Take the case of Orange, County, California as a prime example.  Yes, city, county and state governments were beginning to play the game fifteen years ago.  One might ponder from where the derivatives salespeople and trainers came to "educate" our governments and governments around the globe about the enormous profits that were possible from these transactions.  Yep.....the same banks, investment banks,  insurance companies and off shore hedge funds which tore us apart two years ago were responsible for sending their "whiz kids" out into the marketplace to inform our institutions about what they were missing.

 

Toward the end of the 1990s, we began to hear about "rogue" derivatives traders run amok who cost their companies hundreds of millions of dollars.  Remember Barings Bank? How about the acronyms BCCI and LTCM?  One still can go into a search engine and find a Wikipedia history on them.  BCCI was more of a banking conglomerate, and LTCM was more of a hedge fund.  Both outfits fell on their respective swords after a series of derivatives blowouts.  Even Proctor and Gamble was clipped for 150 million in 1994 because its traders were on the wrong side of interest rate and currency derivatives.  I remember the CEO blowing it off publicly as being a mere blip,  The treasurer, however, was put on "special assignment". 

 

Today one could look at the financial news to see that Canada and especially its banks have held up rather well during this serious global economic downturn.  Why?  Central regulation forces Canadian banks to have higher reserve requirements than U.S. banks.  Insurance must be purchased when banks have less than 20% down payment on loans.  Using deposits on hand at Canadian banks to speculate in derivatives cannot be accomplished thanks to that regulatory process.  Very simple.  Case closed.

 

Merrill Lynch fell on its face.  Bear Stearns fell on its face.  Lehman Bros. fell on its face.  AIG fell on its face.  Wachovia fell on its face.  Washington Mutual fell on its face.  One might surmise that, if Mr. Bernanke had it to do all over again, he might have tried a little harder to find a buyer for Lehman (in business since 1850) like he did for Mother Merrill and The Bear.  The country was livid that the government bailed out AIG.  What the country didn't know and is just starting to find out, however, was how tightly wound AIG was to the global financial network via the leveraged derivatives markets.  The domino effect of failures would not have been a pretty sight to watch.  Stocks, in general, might have traded no higher than absolute tangible liquidation value per share.

 

Stand By.

Posted via email from gary w oakes's posterous