20111213 - the ft's year in finance

8/3/2019 20111213 - The FT's Year in Finance

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THE FTS

YEAR IN FINANCEFINANCIAL TIMES SPECIAL REPORT | Tuesday December 13 2011

Lessons from history

Japans interest ratedilemma casts ashadow over theUS Fed, saysGillian TettPage 2

InsideAnalysis PatrickJenkins, BrookeMasters and TomBraithwaite find littleconsensus on how tofix the banking systemPage 2

Undercovereconomist TimHarford takes usbehind the scenes withthe inventor of thePonzi scheme Page 2

FinancialmarketsIt ismadnessto follow amartingalebettingstrategy, says John KayPage 5

Inside businessTom Braithwaiteexplores arcane ways

to reduce risk Page 5MF GlobalJohnGappertells afable ofEmperorCorzine

and his Goldmanclothes Page 6

Eurozone Germanyschoice is a fateful one,writes Martin WolfPage 5

Banks Bob Diamond,chief executiveof Barclays, givesan unconvincingdefence of amuch-loathed sector,writes Martin WolfPage 6

This was the year thesovereign debt cri-sis struck Europe.O ne b y o ne , t he

dominoes fell: Greece, Ire-land, Portugal, Spain andItaly. Bond yields soared,bank shares crashed, gov-ernments collapsed. At thetime of writing, financialmarkets were focused on

the risk of a second creditcrunch.

The Financial Times hasoccupied a ringside seatsince the global financialcrisis erupted in the sum-mer of 2007. Our commenta-tors and reporters havetackled the crisis in all itsdimensions: the sub-primelending spree in the US,e xc es s l ev er ag e o f t heinvestment banks, regula-tory failures, global eco-nomic imbalances, the sov-ereign debt squeeze, andnow the existential threatto Europes single currency,the euro.

This report is intended togive a flavour of the FTscoverage of these momen-tous events. Natur ally,there are gaps.

There is no space for ourpopular A-List commenta-tors such as George Soros,Mohamed El-Erian of Pimco

a nd N ou ri el R ou bi ni(though samples of theirbest writing can be foundonline at blogs.ft.com/the-a-l is t a nd w ww .f t. co m/finance-2011). Other contri-

butions that can be foundonline cover important top-ics such as the growth ofthe shadow banking sectorin China, the increasinginfluence of sovereignwealth funds based in theMiddle East and Asia, andthe anti-capitalist Occupymovement that surfaced inbig cities around the world.

The Occupy movementwas inchoate, but it spoketo a widespread disillusionwith capitalism specifi-cally financial capitalism.The public remains angryand frustrated at the cost ofrescuing the banking sys-tem, a cost largely born byt ax pa ye rs r at he r t ha nshareholders or bondhold-ers. Bankers have donetheir cause scant good by

continuing to award them-selves generous remunera-tion packages (though inthe end, of course, share-holders have the final say).

An egregious example of

skewed incentives and com-pensation emerged with thecollapse of MF Global, atrading house run by JonCorzine, formerly co-head ofGoldman Sachs, governor ofNew Jersey and US Senatorrepresenting the GardenState. Mr Corzines dreamwas to turn MF Global intoa rival of Goldman, and hemade a big bet on a recov-ery in European bond mar-kets. The bet was not onlyill-timed, it was uncovered.

John Gappers parable ofEmperor Corzines Goldmanclothes subtly draws onHans Christian Andersensfairy tale to capture Mr Cor-zines delusional position.But it also raises questionsabout the effectiveness ofpost-crisis regulatory scru-

tiny in the US.This is a theme reprised

by Megan Murphy and HaigSimonian in their account,available online, of a $2.3bnrogue trading scandal at

UBS, the oft-troubled Swissglobal investment bank.

The way Jamie Dimon,head of JPMorgan Chase,tells it, the banks are beingforced to double-down oncapital to achieve lower riskweights. Mr Dimon toldTom Braithwaite, our USbanking editor, that theBasel III inter national

reforms were anti-Ameri-can. But as our reporterexplains: banks are delever-aging by cutting the size of

their balance sheets, fur-ther reducing credit to abattered economy. GillianTett, US managing editorand a former Tokyo corre-spondent, spells out the

comparisons with Japanslost decade and thereforethe policy dilemma for theUS Federal Reserve.

C re di t r at io ni ng i salready generating a slow-down in the east and rais-ing the spectre of a 2012recession in Europe. This isdoubly alar ming in thelight of the eurozones trou-bles. Martin Wolf has writ-ten many brilliant commen-taries this year, particularlyon the eurozone. His col-umn on Germanys fatefulpolicy choices is one of themost outstanding.

We are witnessing, hewrites, a lethal interplaybetween fears of sovereigninsolvency, emerging sover-eign illiquidity and finan-cial stress. For a different

perspective, readers shouldturn to John Kay, our resi-dent wit. He comparesEuropes response to a mar-tingale betting strategy:each time you lose, you

increase your stake: to thepoint at which a win on thenext game would recoup allyour losses and leave youahead. Of course, JohnKay writes, the conditionis that you need to be infi-n it el y r ic h b ef or e y oustart.

In September, the FT pub-lished a series on the futureof banking. Patrick Jenkins,banking editor, Brooke Mas-ters, global regulation cor-r es p on de nt , a nd T omBraithwaite wrote the open-ing article on how the bigi nv es tm en t b an ks a readapting to the new age ofausterity. Leverage will belower and so will returns.Banks will go back tobasics such as acquiringdeposits, lending them on,

cash management, tradef in an ce a nd f or ei gnexchange.

That would suit MartinWolf, who was a member ofthe Independent Commis-

sion on Banking set up bythe UK government to lookat the causes of the crash,deter mine how to boostcompetition in the sectorand make recommendationsto strengthen safety in thesystem. The ICBs recom-mendations, chiefly to endthe implicit cross-subsidy ofrisky investment bankingvia retail deposits, will beimplemented by the govern-ment in 2012. Bob Diamond,chief executive of Barclays,countered in the inauguralToday Business Lecturet ha t b an ks n ee de d t obecome better and moreeffective citizens. MartinWolf takes him at his word.

And, finally, for a touchof light relief, there is TimHarfords tongue-in-cheek

account of the extraordi-n ar y g ro wt h o f P on zischemes. As Charles Ponzihimself might have said:Tings aint wot they usedto be.

Contagion in an age of austerityThe year has beenpunctuated by the thud of fallingdominoes, writesLionel Barber,FT Editor

The condition isthat you need tobe infinitely richbefore you start

www.ft.com/finance-2011 | twitter.com/ftreports


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2 FINANCIAL TIMES TUESDAY DECEMBER 13 2011

The FTs Year in Finance

Two world pokerchampions and otherleaders of one of the largestinternet card gaming sitesturned the company into amassive Ponzi scheme,wrongly taking out morethan $440m from playeraccounts, US officialsalleged on Tuesday.

The Financial Times,September 21 2011.

Office of Charles Ponzi &Sons:

Mr Ponzi, have you seenwhat the US JusticeDepartment is saying aboutthis poker website?

(Sighs) Dont tell me,Massimo: they say its aPonzi scheme?

Youve got it in one, MrPonzi.

This is outrageous! Callmy lawyer! Who do thesebastards think they are? Iam Charles Ponzi! ThePonzi scheme is mycreation!

I dont think Full TiltPoker are planning toinfringe on the trademark.

Im not worried aboutFull Tilt Poker. Im upsetabout these sanctimoniousasses who keep sayingPonzi, Ponzi, Ponzi andthey know nothing!

If a company goes

bankrupt but the managersget paid, its a Ponzischeme. Internet bubblecompanies are a Ponzischeme. If its agovernment policy theydont like, its a Ponzischeme.

Where does it stop?Some kid steals baseballcards from a candy storeand its a Ponzi scheme?They think Im a shoplifteror something?

What do they say thepoker website didanyway?

Well, the US JusticeDepartment says that someof the company directorspaid themselveshandsomely while theywere struggling to take inmoney from new players.

Why were theystruggling to take inmoney?

Because the USgovernment was trying tomake online poker and allrelated transactionsillegal.

Oh well. It doesntmatter to me if they did itor not. What these clownsat the US JusticeDepartment are describingis not a proper Ponzischeme at all.

A proper, classic,elegant Ponzi scheme is aninvestment offer that paysinvestors high returns. Youknow this.

I know this, Mr Ponzi.You know this. The

high returns attract newinvestors and often theold investors keep theirmoney in too. As long asthe money coming in fromnew investors is enough tocover the occasionalinvestor who cashes out and of course the dividends

taken out by the schemescreator then all is well. Itis a thing of beauty.

It certainly is, MrPonzi.

If these guys looted thecash register while theircompany was goingbankrupt, thats notworthy of the great nameof Ponzi. Ill sue theprosecutors for tarnishingmy brand name.

And Mr Perry.Who?Governor Rick Perry.

Hes running forpresident.

What about him?He said that social

security was a Ponzischeme.

He said what? Who thehell does he think he is?

I think he thinks hesthe next president of theUnited States.

Well screw him! ImCharles Ponzi! Socialsecurity isnt a Ponzischeme! Its just a welfarepayment thats going to bemore expensive because ofdemographic change.

I understand, boss. But well, isnt it a little bit ofa Ponzi scheme? I mean, itdepends on eachgeneration being largerthan the previous one.

Crap! It does not dependon that at all. Sure, itscheaper if there are lots ofyoung people around. Butsocial security is perfectly

affordable with a bit moretax or a slightly lower pay-out. Its nothing like aPonzi scheme. With someadaptations it could runforever. But a good,audacious Ponzi schemecan become unsustainablein months.

Shall we sue Mr Madofftoo, then, sir?

No, no. Bernie is fine,Bernie carried off a properPonzi scheme. He surekept it going for a longtime. I cannot complain. Iwish we had trademarkedthe Ponzi name, but Icannot blame Bernie forthat.

Thats very big of you,Mr Ponzi.

I suppose I should notbe too upset. The morepeople carelessly talkabout Ponzi schemes, themore confused everybodybecomes. It will becomeeasier and easier to operatea real Ponzi scheme. Soeverything is not so bad.

You look tired, sir. Letsget some pizza and relax.

A good idea, Massimo! Ihave some vouchers fromthis internet thing,Groupon. It seems the localpizzeria is offering somegreat deals.

Ah. Mr Ponzi?Yes?Have you heard what

some people are sayingabout Groupon?

My lawyer, Massimo!My lawyer at once!

[email protected]

This article wasoriginally published onSeptember 23 2011.

Patenting thePonzi: anextraordinary

tale of growthUndercovereconomistTim Harfordtakesus behind thescenes with agrand schemer

Dorotea, a thirty-some-thing one-woman ceram-ics entrepreneur basedin the remote forests of

Peru, knows all about the globalfinancial crisis. She might not befamiliar with the intricacies ofLehman Brothers demise in 2008,nor with the succeeding slew ofregulations intended to fix a bro-ken banking system. But sheknows she is lucky. If she weretrying today to get the loan of1,200 sol for a new kiln that shesecured a few years ago, shewould be disappointed.

Like virtually every bank world-wide, her micro-lender, Mibanco,has had to reduce the risks towhich it is exposed, and is nolonger granting credit to poverty-stricken businesspeople. Were

still lending, says her local man-ager. But were looking for lowerrisks not so poor, not so micro.

Three years after the depths ofthe worst financial crash in eightdecades, it is clearer than everthat the crisis many thoughtended two years ago is draggingon and in some ways, particu-larly in the US and across theeurozone, intensifying.

Businesses and politicians saycredit is either unavailable or tooexpensive. Banks complain thatprofits are being squeezed so hardthat investors are deserting them.Regulators are left wonderingwhether their natural crisisresponse to draft tough newrules is building a stronger sys-tem as intended or rather exacer-bating the problems of a fragileglobal economy.

With hindsight, it is clear thestructure of the sector in theyears before 2007 was an accidentwaiting to happen. Institutionshad grown distorted in the pur-

suit of bumper profits. They heldlittle equity capital to protectthemselves and what they didhave was in many cases amplifiedby as much as 50 times with debtinstruments. Vast profits weremade from borrowing cheaply,often short term, and assumingthe risks inherent in productsfrom domestic mortgages to com-plex derivatives were negligible.

Today, those building blocks ofprofitability generating returnson equity of up to 25 or 30 percent, five times the norm formany blue-chip industrial compa-nies are gone. Many banks nowhold triple the equity they usedto, and as much as six times theliquid funding. Typical leveragemultiples are down to 20. Riskshave been reassessed. And profitshave slumped. On the banks ownpreferred measure, ROE, whichhas historically flattered perform-ance by relating returns only tothose thin equity cushions, thebest they can aspire to now is halfthe pre-crisis range.

Citigroup, a big US casualty,has shrunk its assets loans,mortgages and other credit dra-matically. The world haschanged, says Alberto Verme,

joint chief executive of its Euro-pean operations. Banks are goingback to basics getting deposits,lending them on and managingwhat are increasingly importantrequirements for customers cash management, trade finance,foreign exchange.

Regulators in turn have pushedthrough a raft of rules on theamount of equity and liquidityinstitutions should hold.

Though most are part of thenew standards from the Baselcommittee, the global regulator,to be phased in by 2019, analystsand investors have applied pres-sure for early compliance. Theirmaxim for the past couple ofyears has been simple: the higherthe capital ratio specifically

equity as a proportion of risk-weighted assets the better.

Its quite clear that the bank-ing system today is safer than itwas a few years ago, says BobPenn, partner at global law firmAllen & Overy. Is it regulatoryaction or simply market responseto a crisis?

Either way, the crisis has founda second wind. The direct costsborne by governments three yearsago of bailing out broken banks,combined with the indirect costsof the economic slowdown thataccompanied the crash in the sec-tor and long-term overborrowingcoming home to roost, haveshown up in unsustainable sover-eign debt burdens from Europe tothe US. That is feeding back intothe still-fragile banking system,as parts of institutions tradition-ally safe portfolios of governmentbond investments have slumpedin value.

In this balance-sheet restruc-turing process, the uncertaintiesright now are within housing andwith governments, says RichardBrown, chief economist at theFederal Deposit Insurance Corpo-ration, which guarantees US bankdeposits and supervises the indus-try.

The irony is that one of thebalance sheets that is furthestalong in being repaired is that ofUS financial institutions. That isone of the pluses on the ledger forthe economy.

Some believe the root problemis that reforms have been insuffi-cient. The structural changesthat have been introduced andplanned will not make [the sys-

tem] safe enough, says ProfessorAnat Admati of Stanford Univer-sity.

By way of example, the latesttargets of the markets bearish-ness are French banks that, withthe support of their national regu-lator, have resisted following thedrive led by Switzerland, Swedenand the UK to boost capital levelsto new heights. At the same time,BNP Paribas, Socit Gnraleand Crdit Agricole all have out-sized exposures to Greece.

Policymakers are struggling tofix the flawed fundamentals ofeurozone economies withoutburning through banks capital

cushions. But in the meantime,the supply of short-term liquidfunding to many institutionsacross the continent is drying up,in a re-enactment of the jittersthat killed off the likes of North-ern Rock in the UK and Lehmanin the US in 2007-08.

The fundamental problems inthe euro area are only worseningover time, says Ulf Riese, financedirector at Swedens Han-delsbanken, whose low-risk busi-ness model has made it a rare safehaven among European peers.Liquidity for many banks is get-ting shorter term or is reliant ongovernment measures.

The September 9 deadline forprivate-sector holders of Greeksovereign bonds to sign up to avoluntary deal to extend the termfor up to 10 years could triggeranother round of bearishnessacross the eurozone. Bankers pre-dict participation will fall short ofthe 90 per cent target, whichcould endanger the next trancheof Greek bail-out money if politi-cians feel the burden is not beingshared fairly. The fragility of themarkets has prompted some nor-mally hardline reformers appar-ently to question the wisdom ofan unbending approach. AndrewHaldane, executive director forfinancial stability at the Bank ofEngland, last month praised thehandling of bank regulation inthe 1930s by US President Frank-lin Roosevelt specifically loosen-ing rules during the Great Depres-sion in a successful bid to boostlending.

Bankers, unsurprisingly, agree.They point out, for example, thatlenders traditional role of mediat-ing between the capital marketsand corporate borrowers may nolonger be economically viable,now that so many have beendowngraded by credit rating agen-cies. Nowadays, a lot of bankshave a higher cost of fundingthan corporates that makes itvery difficult to be a lender tocorporates, says Mr Riese.

When it comes to blue-chip cli-ents, with easy direct access tocapital markets themselves, thatmay be a problem only for theirbanks. Loans have traditionallybeen a loss-leader product, givingthe lender a relationship with a

customer, and a basis on which tocross-sell more profitable busi-ness.

But for small and medium-sizedenterprises, banks shortage offunding poses a real problem,

both politically and economically.SME lending, which attractshigher regulatory capital charges,is especially sensitive in Europe,where most employment is bysmaller businesses.

Some reformers believe regula-tors must keep up the pressure for instance, limiting banks abil-ity to pay dividends to sharehold-ers until they have boosted capi-tal levels further through retainedprofits.

There will only be long-termprosperity if we underpin thehealth of our financial system,says Paul Tucker, deputy gover-nor of the Bank of England. Hadthe authorities not pressed thebanking system to have more cap-ital, we would probably be in aworse position now.

The Institute of InternationalFinance, however, which repre-sents the industry globally, esti-mated this week that complyingwith new rules will force financialgroups to come up with $1,300bn

in additional equity. They predictthe cumulative effect could pushup interest rates on loans by 3.6percentage points over the nextfive years and cut global grossdomestic product by 3.2 per centby 2015.

Those who favour a more prag-matic approach to reform have abroader complaint, too that theprocess risks creating a wholenew set of distortions that couldprove just as dangerous as thosethat preceded the 2008 crash.

Jan Hommen, chief executive ofDutch bank ING, says crackingdown on banks will shift risk intoshadow institutions, from hedgefunds to industrial companiesbranching into lending. I amnervous that the regulated finan-cial markets which are basicallythe oil that greases the economy are being too tightly regulated,he says.

There are gripes, too, about theside-effects of multiple uncoordi-nated reforms. If politicians and

regulators are not capable of join-ing up their thinking, what hopedo we have of a sensible out-come? says Allen & Overys MrPenn.

Taxpayer anger about the 2008rescues has also limited theoptions available for dealing withfuture crises. For example, theFed cannot direct emergencylending to a single institution.

I worry that the risk of runs isstill very much there, says PhilSuttle, chief economist at the IIF,referring to the restrictions on theFed. If Im an unsecured shorter-term depositor with the bankingsystem that isnt clearly insured,Ive probably got more ratherthan less worries at this point.

A still bigger concern is the dis-torting effect that the clampdownon western banks might have onthe few remaining growth mar-kets most strikingly Asia.

In very macro terms, Chinaclearly has a long way to run interms of growth. But that doesntmean there wont be bumps alongthe way, says an Asia expert atone bank. The continent hassteered clear of much of thewests regulatory reform, so USand European banks are divertingan artificially high volume ofinvestment into the region fromlending to establishing new trad-ing floors helping to inflateexisting bubbles.

But the biggest existential ques-tion remains the basic one oflending capacity. And only whenthe economys weak demand forcredit finally strengthens, testingthe banks capacity to lend withtheir new capital and liquidityconstraints, will the world reallyknow whether the future of bank-ing stacks up.

[email protected]@[email protected]

This article was originally published on September 7 2011.

The hunt for a common frontAnalysis

Patrick Jenkins,Brooke Masters and

Tom Braithwaite findlittle consensus on howto fix the bank system

Slightly more than adecade ago, I spent manyhours at the Bank of Japantalking with officials aboutthe paradoxes of ultra lowrates. At the time, BoJofficials faced intensepressure from politiciansand markets to boost

growth; so they were dulyimplementing quantitativeeasing or their zerointerest rate policy (Zirp).

However, the more theyexperimented with Zirp, themore sceptical they seemedabout whether it reallyworked. The essential

problem, they moaned, wasthat Japans financialsystem was so broken ithad become bifurcated:some companiesdesperately needed cash,but could not borrowbecause the banks were toorisk-averse to assume creditrisk, with or without Zirp.

However, healthycompanies that did notneed loans were finding itlaughably easy to raisemoney. The result was aclassic liquidity trap. And,as such, it left men such asMasaru Hayami, then BoJgovernor, privately joking

he really ought to raiserates not cut them sincethat, at least, would makelong-suffering savers happy.

These days, the shadowof Japan is hanging overAmericas Federal Reserve(and not just because whenBen Bernanke was an

academic, he used to writeextensively on Zirp, andquestion whether Hayamiwas trying hard enough).In September, the Fedannounced a variant in itshome-spun version of Zirp:the so-called Twistoperation, a move that seesit purchasing long-termbonds and mortgagesecurities, in place of short-term debt and governmentbonds.

This aims to lower long-term borrowing costs, andthus supply more credit tothe business sector andmortgage world.

However, the Fedsproblem like Japan adecade ago is, as theInternational MonetaryFund puts it in its latestfinancial stability report,that the economy isbifurcated. Many largeAmerican companies,

particularly those withglobal operations, arehighly profitable andliquid. Unsurprisingly, forthem bank lendingconditions and capitalmarket financing remaineasy, the IMF notes.

But many small andmedium-sized companies or the entities thattypically create jobs insidethe US, not overseas findit hard to raise funds. Asurvey conducted by theInternational FranchiseAssociation in Washington,for example, notes thatwhereas in March half of

its members expectedcredit conditions toimprove soon, six monthslater less than a quarterexpect any easing; even asTreasury yields fall.

There is bifurcation inthe mortgage market too.In late September Freddie

Mac announced that theaverage rate on aconventional fixed-rate 30-year mortgage had tumbledto an all-time low of 4.01per cent (and in westernUS regions, just 3.95 percent), following OperationTwist. Wall Street bankers

are buzzing with tales ofsavvy financiersrefinancing home loans atrock-bottom rates.

But, as a report from theInstitute of InternationalFinance says, In order totake advantage of lower

mortgage rates, borrowershave to refinance theirmortgages, which can bedifficult to impossible, ifthe value of home equityhas been eroded. Twist, inother words, does nothingfor households withnegative equity (estimatedto be about a quarter ofthe total); nor those indistress (another quarter.)Worse still, Fannie andFreddie are not allowed torefinance their loans. Littlewonder mortgage approvalsare falling fastest incommunities with highlevels of negative equity

and repossessions precisely the area that theFed wants to help.

Is there any solution? Atthe IMF meetings in lateSeptember, proposals fellinto three strands. Somevoices, particularly inEurope, want regulators to

urge the banks to lend,via targets or politicalpressure. Witness, forexample, the calls madesubsequently by theFinancial Policy Committeein the UK (which alsofaces a bifurcationproblem). However, banklobbyists retort that abetter solution would be towater down efforts totighten capital standards;according to the IIF, whatis hurting credit provisionis excessive regulation anduncertainty.

Meanwhile, someeconomists are pressing

the Fed and other centralbanks to get more directlyinvolved in lendingthemselves. Alan Blinder,the former vice-chairmanof the Fed, for example,likes the idea of the Fedpurchasing more mortgagebonds, or even corporate

loans; another proposalfloating around is tosecuritise loans to smallAmerican businesses,which could then bepurchased by the Fed, viaanother version of Twist.

Such ideas may help atthe margins; purchasingsecuritised bundles of SMEloans, for example, seemssensible. But none is asilver bullet, least of allwhen eurozone woes aremaking US banks evenmore risk-averse. IfHayami were still alivetoday, it would beinteresting to know what

advice he would give; andeven more interesting toknow how Bernanke mightrespond.

[email protected]

This article wasoriginally published onSeptember 29 2011.

Japans interest rate dilemma casts a shadow over the Fed

Gillian Tett

The Feds problem like Japan adecade ago isthat the economyis bifurcated

Asias banks The fish always stinks from the head

Liu Mingkang, Chinas chiefbanking regulator, has a folksyway of explaining his work: Thefish always stinks from the head,

writes Simon Rabinovitch.This belief that regulation must

focus on banks head offices canbe seen in Chinas zeal to enforcethe Basel III rules. The ChinaBanking Regulatory Commissionhas been pushing ahead with a setof rules that is stricter than whathas been agreed internationally.

Basel IIIs minimum tier onecommon equity requirement is 4.5per cent; China has set its bar at5 per cent. For the leverage ratio,a safety net if risk-weightings fail,Basel III requires at least 3 per

cent of total assets; China hasopted for 4 per cent.

Beijing has ordered its biggestbanks to meet the capitalrequirements by 2013, whereasbanks in developed markets have

until 2015. Chinese bankers havebeen quick to fall in line. Thedifference with Europe and the USis easy to explain. Top bankexecutives are appointed by theCommunist party and answer tothe government.

Chinas banking sector had acapital ratio of 12.2 per cent at theend of June, well beyond Basel IIIstandards. Banks around Asia arein a similar position.

Japan has stood out, however,as its regulators worked hard toprotect banks from having tomove too quickly to increase theircapital stocks.

But the absence of complaintsfrom Chinese bankers does not

mean that the new regulations willbe painless. Wu Xiaoling, a formercentral bank vice-governor, hasbeen unusually candid, warningthat banks deemed systemicallyimportant could face a large

funding gap in the next five years.Concern that they will have to tapequity markets to meet capitalrules is one reason for theirlacklustre share performance inthe past year.

The tough rules obscure themain risk for Chinese banks: toomuch government. With all majorlenders owned by the state, theircommercial decisions are heavilydictated by Beijing.

A case in point was their surgein lending in the global financialcrisis, when the government usedthe banks to fund its stimulusspending. The damage in badloans is just beginning to emergeand analysts say it will cast a

shadow over the Chinese bankingsector for years to come.

[email protected]

This article was originallypublished on September 7 2011.

Houses not yet in order: the shortage of funding for banks is a real problem for small businesses

Liquidity for manybanks is getting shorterterm or is reliant ongovernment measures

It will becomeeasier to operate areal Ponzi scheme.

So everything is notso bad


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The martingale is not a songbird,but a betting strategy. Each timeyou lose, you increase your stake: tothe point at which a win on the nextgame would recoup all your lossesand leave you ahead.

Since you will win sooner or later,you are certain to come home with asmall profit. Provided you areinfinitely rich before you start.Otherwise, if you regularly engage inmartingales, you will eventually gobankrupt and the richer you are,the larger the scale of bankruptcy.

Since anyone who studies theproblem knows that ruin is theoutcome, your bank, or yourbookmaker, will probably call a haltto the game while the shirt remainson your back. Such capitulation willleave you with a large loss, and anenduring grievance that others havedeprived you of a great coup.

Martingales and related strategiesare the familiar currency of financialmarkets. Risk managers struggle, not

always successfully, to control themartingales of rogue traders. Loancovenants may specify that whenyour initial collateral becomesinsufficient you must offer more.Governments have responded to eachrecent financial crisis by feedingenough money into the market tostave off immediate collapse.

Bold risk-taking has always beencharacteristic of the European Union.The architects of the Europeanproject believed that if themechanics of integration weredeveloped rapidly, the institutionsand electorates of member states,and the degree of real economicintegration across national

boundaries, would eventually catchup. This approach has mostlyworked. But as with most gamingsystems, it works until it doesnt.

Whenever European institutionshave failed to end the current crisis,they have returned with a new,larger, commitment. We will dowhat it takes is the strategy, if itcan be called that. Just in time, just

enough, is how my colleague MartinWolf described the tactics in lateNovember. These are the key partsof the martingale system. But debtmarkets illustrate a malevolentgame. A player on the other side ofthe table global financial markets has very large resources, and can

ensure that each round can beplayed for very large stakes.

The wise persons reaction to thecasino is not to go there. The nextbest course is to plan an early night.Leave while you are ahead, and ifyou cannot do so, accept a smallloss. If the eurozone had quicklyrecognised defeat in Greece, it would

have suffered a manageable failure.Instead it has followed themartingale. As the size of the betgrows after a run of losses, thecommitment to do what it takesbecomes steadily less credible.

The gambler who is confident hissystem will work looks to richfriends. When the indulgence of

Berlin was exhausted, a banker wasdispatched to Beijing. Now theplayers look to the only remainingcredible supporter. Surely theEuropean Central Bank can enablethem to see the night through. TheECB really does have infiniteresources: if it runs out of money, itcan print more.

Up to a point. Money created by acentral bank is not free if it were,we could all be as rich as Croesus.The resources of a monetary agencycome either directly from taxpayersor indirectly from everyone throughgeneral inflation. To fund the bet theECB would have to stand ready tobuy not just every eurozonegovernment bond issued so far, butany that might be issued. And more.The subprime and Lehman failuresdemonstrated that the amounts ofmoney that could be gambled ondefault were potentially far largerthan the actual amounts at risk.

Of course, say the advocates ofthis course, if only the banker wouldpromise to underwrite our losses he

would not actually have to pay. Ifyou will only lend me a bit moremoney, says the gambler, you willget it all back, and more. That is theseductive song of the martingale.

[email protected]

This article was originally published on November 22 2011.

It is madness to follow amartingale betting strategy

John Kay

Martingales andrelated strategies arethe familiar currency offinancial markets

A top US regulator takesthe drastic step of suspend-ing bank capital require-ments. The global crisis isso bleak that the FederalDeposit Insurance Corpora-tion says the country needsbanks to focus on lendingrather than the additionalstability of higher capital.

The question, accordingt o t he F DI C, is n otwhether a bank has enoughcapital for the type of assetswhich it now holds and therisks which it now appears

to face, but whether it hasenough capital to enable itto assume the proper andreasonable risks of partici-pating in the financing ofbusiness enterprise.

But before Brian Moyni-

han of Bank of America andhis fellow chief executivespop the champagne corks, Ih av e a c la ri fi ca ti on .Although the passage isfrom the FDIC, I stumbledacross it in the FT archives,and it comes from 1944.

Todays regulators aremore hawkish. With memo-ries of the 2008 crisis stillfresh, bank s r ound theworld have been ordered toachieve a 7 per cent ratio ofc or e c ap it al t o r is k-weighted assets by 2019 asp ar t o f t he B as el I IIreforms. The largest must

reach 9.5 per cent. WithEuropean banks still toofeeble to withstand sover-eign defaults, they arebeing instructed to acceler-ate capital building.

How they do this will

prove increasingly contro-versial. Anders Borg, Swed-ish finance minister, said inOctober that the first solu-tion [should be] withhold-ing dividends and tappingprofits. Others in his campsay raising capital in themarket should be the sec-ond solution.

If policymakers wantbanks to raise fresh capitalthey are going to have tof or ce i t t o h ap pe n a ndpolice it vigorously. Withthe share prices of the larg-est international banksdown 30-60 per cent this

year, chief executives arereluctant to inflict morepain on long-sufferingshareholders (includingthemselves) by dilutingthem in an equity raising.Even Mr Moynihan, whose

bank is seen as the weakestof the top five in the US,has ruled that out.

At the same time, fearfulof losing top staff, banksare still preparing to payout about 40 per cent of their revenues in salariesand bonuses this year. Andthe Federal Reserve hasallowed most large USbanks to increase their divi-dend pay-outs and sharebuy-back s, cutting theamount available to buildup capital.

With this set of instruc-tions and incentives the

banks are going to do pre-cisely what the wartimeFDIC wanted to avoid: solu-tion three cut the size oftheir balance sheets, fur-ther reducing credit to abattered economy.

But there is a fourth solu-tion that has received lim-ited attention yet mayprove crucial: magical Alicein Wonderland tricks offinancial innovation. Ratherthan increase the numera-tor of the capital ratio byhurting shareholders andemployees or reduce thedenominator by hurtingbusinesses and customers,bankers are quietly gettingcreative once more.

The opportunity comesbecause of regulators deci-sion to calculate capitalrules using risk-weighted

assets rather than totalassets. So the safest securi-ties, such as US Treasuries,do not count as assets at allfor the ratio, but the riski-est such as long-ter mstructured credit assets

count at double their statedvalue or more.Jamie Dimon, JPMorgans

chief executive, said inOctober that he intended tomanage the hell out of RWA to reach the higherlevels. Morgan Stanleyr ev ea le d t ha t i ts r is k-weighted assets had bal-looned by $44bn after theFed said the bank was man-aging the hell out of itsassets too much and told itto stop.

A senior executive at athird bank told me that itwas scouring its balance

sheet, looking for assetsthat could be structured dif-ferently to achieve lowerrisk weights. And, as theFT reported in October,hedge funds and insurersa re a ct iv el y i nv ol ve d

behind the scenes, seekingnew structures to buy orguarantee a slice of risk onbanks books.

So by financial alchemy,assets can be transmutedfrom garbage to gold and,therefore, require less capi-tal. A senior regulator tellsme officials are fully expect-i ng v ar io us n ef ar io usschemes to circumvent therules, including structuredtransactions that do notreduce their risk but doreduce their RWA.

This is arcane stuff and itcan easily be lost in the

headlines of whether BaselIII is anti-American, asMr Dimon has said, or anti-European.

Meanwhile, regulators areall suspicious of each other countries that adhere to

the 1944 view of the worldcould be lenient on theirbanks just by turning ablind eye to risk-weightmanipulation.

Whether you call it gam-ing the system or legitimatemanagement, the capitalhawks will need to watchboth the banks and thenational regulators if RWAis not to mean Really WeirdAccounting.

[email protected]

This article was originally published on October 242011.

Banks turn to financial alchemy in search for capitalInside business

Tom Braithwaite

explores arcaneways to reduce risk

Perhaps future historians willconsider Maastricht a decisive steptowards the emergence of a stable,European-wide power. Yet there isanother, darker possibility. The effortto bind states together may lead,instead, to a huge increase in

frictions among them. If so, the eventwould meet the classical definition oftragedy: hubris (arrogance); ate(folly); nemesis (destruction).

I wrote the above in the FinancialTimes almost 20 years ago. My fearsare coming true. This crisis has donemore than demonstrate that theinitial design of the eurozone wasdefective, as most intelligent analyststhen knew; it has also revealed and, in the process, exacerbated afundamental lack of trust, let alonesense of shared identity, among thepeoples locked together in what hasbecome a marriage of inconvenience.

The extent of the breakdown wasnot brought home by the resignationof Germanys Jrgen Stark from theboard of the European Central Bank,nor by the looming Greek default, norby new constraints imposed by theGerman constitutional court. Whatbrought it home was a visit to Rome.

I heard one Italian policymaker say:We gave up the old safety valves ofinflation and devaluation in returnfor lower interest rates, but now wedo not even have the low interestrates. Then: Some people seem tothink we have joined a currencyboard, but Italy is not Latvia. And,not least: It would be better to leave

than endure 30 years of pain. Theseremarks speak of a loss of faith inboth the project and the partners.

Jean-Claude Trichet, outgoingpresident of the European CentralBank, has pointed to the banksstellar counter-inflationary record, farbetter than the Bundesbanks. But thelow inflation masked the emergenceof profound imbalances within thezone and the lack of means or will to resolve them. As a result, adefault by a major government, abreak-up of the eurozone or both areconceivable. The consequent flight tosafety, which must include attemptsto hedge cross-border exposures in a

supposedly integrated currency area,threatens a meltdown. We arewitnessing a lethal interplay betweenfears of sovereign insolvency,emerging sovereign illiquidity andfinancial stress.

As designed, the eurozone lackedessential institutions, the mostimportant being a central bank toact as lender of last resort in allimportant markets, a rescue fundlarge enough to ensure liquidity insovereign bond markets and effectiveways of managing a web of sovereigninsolvencies and banking crises.

In the absence of strong institutions,the attitudes and policies of the corecountry have become crucial. Iadmire Germanys reconstructionafter the second world war and afterunification, the commitment toeconomic stability and its first-classexports. Unfortunately, these areinsufficient. German policymakerspersist in viewing the world throughthe lens of a relatively small, openand highly competitive economy. Butthe eurozone is not a small, openeconomy; it is a large and relativelyclosed one. The core country of sucha union must either provide abuoyant market for less creditworthycountries when the latter can no

longer finance their deficits, or it hasto finance them. If the private sectorwill not provide the finance, thepublic sector must do so. If the latterfails to act, a wave of private andpublic sector defaults will occur.These are sure to damage thefinancial sector and exports of thecore country itself, as well.

The failure of Germanys leaders toexplain these facts at home makes itimpossible to solve the crisis.Instead, they indulge in the fantasythat everybody can be a lender,simultaneously. For small, openeconomies such as Latvia andIreland, regaining competitivenessand growth through deflation mightwork. For a big country such asItaly, it is too painful to be credible.Wolfgang Schuble, Germanysfinance minister, may call for suchausterity. It will not happen.

Today, raging fire must be put out.Only then can attempts at building amore fireproof eurozone begin. Theleast bad option would be for theECB to ensure liquidity for solventgovernments and financialinstitutions, without limit. It shouldnot be difficult to argue that buyingbonds is compatible with continuedmonetary stability, since broad moneyhas been growing at a mere 2 percent a year. It is sure to bepolitically hard, however,particularly for Mario Draghi, theincoming Italian ECB president. Yetit is what has to be done given theinadequate size of the Europeanfinancial stability facility if called onto help larger beleaguered euro-

member countries. Politicians mustthen dare to support such action.

What should happen if the Germangovernment decided it could notsupport such a bold step? The ECBshould go ahead anyway rather thanlet a collapse unfold. It would then beup to Germany to decide whether toleave, perhaps with Austria, the

Netherlands and Finland. TheGerman people should be made awarethe results would include a soaringexchange rate, a massive decline inthe profitability of Germanysexports, a huge financial shock and a

sharp fall in gross domestic product.All this would be apart from thefailure of two generations of effortsto build a strong Europeanframework around Germany itself.

Germany possesses a binding vetoover efforts to expand official fiscalsupport. But it is losing control overits central bank. In a crisis so

menacing, the one Europeaninstitution with the capacity to act onthe requisite scale should dare to doso, since the costs of not doing so arebound to prove devastating. That willsurely create a political crisis, but this

would be better than the financialcrisis unleashed by a failure to try.

Germany must choose between aeurozone disturbingly different fromthe larger Germany it expected, orno eurozone at all. I recognise howmuch its leaders and people musthate this choice. But it is the onethey face. Chancellor Angela Merkel

must dare to make that choice,clearly and openly.

[email protected]

This article was originally published on September 13 2011

Germany has

to make afateful choice

Martin Wolf


6/6



Talk is cheap. Action isexpensive. But BobDiamonds inaugural TodayBusiness Lecture wasclever talk. The chiefexecutive of Barclays, oneof the UKs iconic banks,sought to convince hisBBC radio audience thatthe banks are dedicated tosupporting economicgrowth, by taking risks onbehalf of businesses, bigand small. No doubt, hebelieved every word. Butshould you? No.

Mr Diamond is one ofthose clever investmentbankers who, as mycolleague John Kay hasnoted, now manage mostimportant global bankinginstitutions. He focusedon rebuilding trust.Trust does indeed needrebuilding: at a privatediscussion of the finalreport of the IndependentCommission on Banking,on which I served, aConservative member ofparliament stated that

one of the few issues onwhich all constituentsagreed was their loathingfor the bankers.

Mr Diamond argued thatbanks need to show theysupport growth, acceptresponsibility for whathas gone wrong andbecome better and moreeffective citizens. On thefirst, he argued that bankshelp the economy bytaking risks. On thesecond, gone was earliertalk about an end to theperiod of remorse andapology. Instead, we hadmore remorse, along withinsistence that notaxpayer money shouldever again be put at riskto rescue a failed or failingbank. On the last, hestated that, among otherthings: Business mustincrease profits in a waythat creates sustainablevalue, not just short-termgain.

It makes one feel allwarm, does it not? So whyam I cynical? I look atincentives and behaviour,not words.

In a recent Wincottlecture, Andrew Haldane,executive director offinancial stability for theBank of England, pointedto the perverse incentivescaused by limited liability,excessive gearing, the taxbenefits for debt, andgovernment insurance.

Did the economy at leastbenefit from the run-up inleverage? Hardly. We sawhuge rises in banksexposure to one another,which worsened systemic

fragility, and in the pricesof and debt securedagainst property. Whothinks these provideddurable benefits?

Mr Haldane also noted:The purchaser of aportfolio of global bankingstocks in the early 1990s istoday sitting on a real loss.So who exactly isextracting value from theseincentive distortions? Theanswer is twofold: short-term investors and bankmanagement.

It is not enough forbanks to accept theprinciple of strongregulation, as MrDiamond does. We need tosee changes in how banksmanage themselves if weare to believe inprotestations of reform.

First, bank managementsmust stop targeting returnson equity that are

unadjusted for risk,particularly ones as highas 15 per cent, as I haveargued on the WolfExchange. The easy wayto achieve such targets isto raise leverage apractice concealed behindthe smokescreen of

risk-weighting of assets.Robert Jenkins, a memberof the financial policycommittee of the Bank ofEngland, puts it well:Return on equity is thewrong target. Over thepast 10 to 15 years it hashelped to make manybankers rich and loyalshareholders poor.Moreover, it promptsbanks to fight to keeploss absorbing capital low.This makes theirenterprises vulnerableand our financial systemfragile. As the key driverof bank behaviour it hasto go. Amen.

Second, banks shouldwelcome attempts to raisecapital and lower gearing,over time. This is alsothe best way to makeMr Diamonds intentionthat we will never againneed to rescue banksat all plausible. As thingsstand, this is timeinconsistent a promiseunlikely to be fulfilled.Better-capitalised bankswould be more resilient.Furthermore, this must bereal capital against actualassets. The turmoil inmarkets for supposedlysafe sovereign debt showswhy risk weights can be sodangerous.

Third, banks should joinwith other businesses in acampaign to end thedistortions in corporatetaxation in favour ofdebt. There is too muchdebt in the economy.The consequences havebeen dire.

Finally, UK banks should

welcome the ICBs proposalof a ringfence for thedomestic retail bank,partly because it wouldfacilitate the resolution inwhich they believe andbecause it wouldcontribute to restoring aservice culture to retailbanking. But banksshould also be braveenough to say that, atcurrent low interestrates, the free-if-in-creditmodel of banking isunsustainable. If customerswant the services banksprovide, they must expectto pay for them directly.Otherwise, scandals arealmost certain to recur.

These changes are theminimum needed for abanking system run inthe interests ofshareholders, customersand the economy, notbankers. I hope for

speeches from Mr Diamondand his peers on suchlines. I am not holdingmy breath.

[email protected]

This article wasoriginally published on

November 10 2011

Bob Diamond in an

unconvincing defence

Martin Wolf

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Once upon a time, there was anemperor who had been thrown out ofthe kingdom of New Jersey and wasseeking another place to rule.Corzine, for that was his name,opened his wardrobe at home oneday and spotted some clothesglimmering at the back.

Years before, when the emperorhad ruled the illustrious merchanthouse of Goldman, he had also beenforced to leave. To compensate him,the Goldman merchants had woven asuit and cloak out of what theyassured him was their finest fabric.These clothes will shield youalways, said Paulson, the partnerwho had taken the emperors wreath.If implied volatility spikes in theducat options market, put these onand all will be well.

Emperor Corzine donned theGoldman clothes and regardedhimself in the mirror. His cloaklooked threadbare and he thought he

could spy his naked legs through thecloth. That is impossible, he saidto himself. Goldman garments lastfor ever, even in public service. Myeyes are deceiving me.

The emperor wandered along WallStreet and saw that the passers-bywere staring at him, so he told themwhere his clothes had come from.They immediately realised they wereseeing things. They had mistakenhim for a tramp heading to OccupyWall Streets camp for breakfast, buthe was clearly an aristocrat.

The emperor came across a smallmerchant house called MF Globalwhere humble traders were sellingsugar and bales of wheat. Thisreminds me of the farm in the land

of Illinois where I grew up, theemperor said to himself. Perhaps Ican help them to find prosperity.

The emperor had another thought.After he left the house of Goldman,he had been appointed a senator inthe Columbian district, but hadnever become High Treasurer andbeen permitted to sign the greenbanknotes that were used throughoutall realms. Other Goldman partnershad achieved this office, includingPaulson and a wily vizier calledRubin. He envied them.

Emperor Corzine resolved to takeover this small trading house andmake it a rival to Goldman. That

would provoke envy among themerchants who had rejected him andthe peasants of New Jersey. Thepeasants had stormed the emperorspalace in Trenton one day, led by arotund baron called Christie, whospoke their language.

The emperor was ushered into thepresence of MF Globals traders. Thepartners greeted him warmly, sayingthat they were in sore need of hisleadership because many unusualevents had occurred. There havebeen fierce storms in this parish oflate and a flock of black swans hasswum up the East River and ishissing at us, one said.

Fear not the black swans, theemperor assured the traders. Theweather will revert to normal andwhite swans will return. Trust me Ive been around the block a fewtimes. Let me tell you of an arbitragetrade I did on the bonds of sovereignsmany years ago. It took time to workbut I harvested many gold coins.

Some of the traders wondered ifthey should heed the emperor. Hewas oddly attired and his beard wasgrey. Perhaps he is just re-living pastglories, they thought to themselves.But the emperor showed them thelabel sewn inside his worn-out suit.Goldman, they said admiringly.

They are the finest of weavers. Wewere wrong to doubt him.

Shortly afterwards, a messengerarrived from far-off lands with talesof great events. The grand emperorsof France and Germany had settledan argument and lent florins to thesouthern kingdoms that had debasedtheir currency. We should load up,Emperor Corzine cried. We musttrade in size. Here, he told thetreasurer. Borrow 40 more bags ofcoins like this one. Wear my cloakand no one will refuse you.

Then one of the MF Global traderssummoned his courage and spoke up.My Lord, are you certain about

this? he said. The weather is stillstormy, and one of the black swansbit my leg on my way along WallStreet this morning. It left a nastygash. These are strange andunsettling times. Can we trust ourcousins from the old lands?

The emperor thrust out his armangrily and a sleeve appeared to falloff his suit, though the traders knewthat it could not be so. You are amere trader and you do not hobnobwith kings and queens, as I often do.An emperors word is his bond andthese bonds will fetch a nice spreadin the repo market. With a bit ofleverage, its easy money.

For a time, all was well and goldcoins piled up in the trading housestreasury. There were so many that itwas difficult to keep track of whichbelonged to the traders and which tothe farmers whose commodities theybought and sold. Sometimes, thecoins got mixed up in the same bags.

Then one day, bad tidings werereceived from the Athenian empire.The northern emperors had ordainedthat their bankers be taken outsideand given a haircut. Half of thebankers hair had been shorn, andstill the Athenian peasants wantedmore. How can this be? theemperor said in dismay. I warnedthem against democracy.

An angry crowd of farmers wasgathering outside on Wall Street and,as they burst through the doors todemand their coins back, one of thefarmers children pointed at EmperorCorzine in wonder. He has noclothes, the boy cried.

The traders turned to the emperorand realised that the child was right he had been trading naked allalong. Then they saw that he wasstuffing yards of the most exquisitelyshiny silk into a canvas sack. I putthis in my contract, the emperorsaid. Its a golden parachute.

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This article was originally published on November 2 2011

Emperor Corzine and his Goldman clothes

John Gapper

20111213 - the ft's year in finance

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