That's not the only thing this perverse subculture has memory loss
about, and make no mistake about it, financial traders exemplify a
subculture of greed that adversely affect the society it leeches from.
Ethical behavior is another that immediately comes to mind..
Courtesy of Michael Keaney
The unease bubbling in today's brave new financial world
By Gillian Tett
Financial Times: January 19 2007
Last week I received an e-mail that made chilling reading. The author
claimed to be a senior banker with strong feelings about a column I
wrote last week, suggesting that the explosion in structured finance
could be exacerbating the current exuberance of the credit markets, by
creating additional leverage.
"Hi Gillian," the message went. "I have been working in the leveraged
credit and distressed debt sector for 20 years . . . and I have never
seen anything quite like what is currently going on. Market participants
have lost all memory of what risk is and are behaving as if the
so-called wall of liquidity will last indefinitely and that volatility
is a thing of the past.
"I don't think there has ever been a time in history when such a large
proportion of the riskiest credit assets have been owned by such
financially weak institutions . . . with very limited capacity to
withstand adverse credit events and market downturns.
"I am not sure what is worse, talking to market players who generally
believe that 'this time it's different', or to more seasoned players who
. . . privately acknowledge that there is a bubble waiting to burst but
. . . hope problems will not arise until after the next bonus round."
He then relates the case of a typical hedge fund, two times levered.
That looks modest until you realise it is partly backed by fund of
funds' money (which is three times levered) and investing in deeply
subordinated tranches of collateralised debt obligations, which are nine
times levered. "Thus every €1m of CDO bonds [acquired] is effectively
supported by less than €20,000 of end investors' capital - a 2% price
decline in the CDO paper wipes out the capital supporting it.
"The degree of leverage at work . . . is quite frankly frightening," he
concludes. "Very few hedge funds I talk to have got a prayer in the next
downturn. Even more worryingly, most of them don't even expect one."
Since this message arrived via an anonymous e-mail account, it might be
a prank. But I doubt it. For, while I would not normally write an
article about responses to an article (it is the journalist's equivalent
of creating derivatives of derivatives) I am breaking this rule, since I
have recently had numerous e-mails echoing the above points. And most of
these come from named individuals, albeit ones who need to stay
anonymous, since they work for institutions reaping profits from modern
finance.
There is, for example, a credit analyst at a bulge-bracket bank who
worries that rating agencies are stoking up the structured credit boom,
with dangerously little oversight. "[If you] take away the three
anointed interpreters of 'investment grade', that market folds up shop.
I wonder if your readers understand that . . . and the non-trivial
conflict of interest that these agencies sit on top of as publicly
listed, for-profit companies?"
Then there is the (senior) asset manager who thinks leverage is
proliferating because investors believe risk has been dispersed so well
there will never be a crisis, though this proposition remains far from
proven. "I have been involved in [these] markets since the early days,"
he writes. "[But] I wonder if those who are newer to the game truly
understand the impact of a down cycle?"
Another Wall Street banker fears that leverage is proliferating so fast,
via new instruments, that it leaves policy officials powerless. "I hope
that rational investors and asset prices cool off instead of collapse,
like they did in Japan in the 1990s," he writes. "But if they do,
monetary policy will be useless."
To be fair, amid this wave of anxiety I also received a couple of
"soothing" comments. An analyst at JPMorgan, for example, kindly
explained at length the benefits of the CDO boom: namely that these
instruments help investors diversify portfolios; provide long-term
financing for asset managers and reallocate risk.
"Longer term, there may well be a re-pricing of assets as the economy
slows and credit risk increases," he concludes. "But. there is a very
strong case to be made that the CDO market has played a major role in
driving down economic and market volatility over the past 10 years." Let
us hope so. And certainly investors are behaving as if volatility is
disappearing: just look at yesterday's remarkable movements in credit
default swaps. But if there is any moral from my inbox, it is how much
unease - and leverage - is bubbling, largely unseen, in today's Brave
New financial world. That is definitely worth shouting about, even amid
the records now being set in the derivatives sector.
