The Securities and Exchange Commission of La Mancha

I’ve long been a critic of the ridiculous regime created by NRSRO legislation, that is, the Rating Agencies, or really, S&P, Moody’s, and Fitch.  There are so many problems from top to bottom, left to right that I’m not even going to begin to list them here.  I will, however, quote what I think is a rather eloquent description of the core problem from a man far smarter than I: David Rowe in a post he wrote on the Kamakura Corporation blog (emphasis mine, as usual).

Currently, the US Securities and Exchange Commission (SEC) is soliciting comments on various proposals to reform the institutional framework of credit ratings. The supervisor wants to ensure effective ratings, as if there is some objective truth that can be discovered as long as the right incentives are in place. In fact, when dealing with innovative, highly complex and historically untested structures, no such objective truth exists. The perceived credit quality of such instruments can be as diverse as views on whether a given company’s shares are a buy or a sell. Imposing a one-size-fits-all rating scheme risks unrealistically homogenising market perceptions that should be highly diverse if adequate information for detailed analysis was widely available. Furthermore, it is just such homogenised perceptions that can lead to herd behaviour and major market dislocations when broadly shared expectations prove to be unfounded.

Trying to reform market structure in search of a non-existent objective measure of credit quality and associated risk amounts to a mission impossible. It is bound to bureaucratise and homogenise ratings, thereby creating an inflexible structure that is vulnerable to a systemic crisis. In fairness, the SEC is only doing what was mandated by the US Congress. Nevertheless, what should be done is to seek a framework that will make all the relevant data underlying such securities readily available in a standard format to a broad community of analysts.

Attacking the independence and objectivity of the ratings agencies due to their business model is easy, but it largely ignores the deeper problem Rowe describes above.  The ratings agency approach to credit analysis is inherently and impossibly broken, and efforts to reform it merely amount to tilting at windmills.

However, while hardly perfect – far from it – I think the equity model and the equity-research-centric approach currently adopted by the SEC would be largely instructive for how to reform the credit research industry.  A not insignificant amount of the information needed to analyze a firm’s credits is already included in the filings publicly-traded firms already make to the SEC.  Why not align the reporting requirements for debt and equity issuers?  Why not incentivize a movement to democratize the credit market just as the equity market was over the past 30 or so years?  Seeds of revolution (or rebellion, depending on your perspective) have long-since been planted with exchange-traded hybrid securities, ETNs, and a myriad of other products and services.

I realize the Herculean (if not downright Sisyphean) effort facing regulators with their current responsibilities from Dodd-Frank, but why not kill several giant birds with one stone instead of ignoring keeping the blinders on until the next inevitable crisis?

Reality vs. Matt Taibbi, Part I

Over the weekend I finally relented and read schmuck “journalist” Matt Taibbi’s most recent allegations against Goldman “Vampire Squid” Sachs.  The plan is to write a longer, more formal response, but in the interim I just want to take a few minutes to address the primary shortcoming of Taibbi’s “work,” namely, that he has no fucking clue what he’s talking about.

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Deutsche Bank's 2011 MBS and Securitization Conference

A journey of 1,000 miles begins with a single step.

It’s fitting my inaugural post is a review of Deutsche Bank’s inaugural MBS and Securitization Conference.  The conference attended by some 60 investors from roughly 40 companies highlights DB’s poor standing in the world of structured finance (SF). Deutsche Bank has never been a major player in the securitized finance market though it has spent billions trying to be. In 1996, DB bought Morgan Grenfell to create Deutsche Morgan Grenfell and hired senior bankers from Goldman Sachs and Merrill Lynch.  When the Russian Currency crisis hit, DMG fired all but 3 of its SF staff after paying almost a billion dollars of guaranteed bonuses. They tried again after the Banker’s Trust purchase and this is their third attempt. Third time is a charm right? Nope.  The conference demonstrated the lack of gravitas so evident at Goldman, Morgan Stanley and even, may they rest in peace, Bear Stearns.

Deutsche bank event planners decided to hold this poorly attended conference not in a fancy hotel (like Citi or Wachovia) but in an auditorium two stories below street level in their “marque building” 60 Wall Street. Fortunately, the poor catering did not make me sick.  Good job of impressing investors.

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SEC Division of Risk, Strategy, & Financial Innovation Could Use A Few Good Men…

I realize the SEC’s task is a gargantuan one, especially considering the severely constrained resources, but there’s just no excuse for things like this.  The SEC’s Division of Risk, Strategy, and Financial Innovation – the group created in 2009 to supposedly “enhance our capabilities and help identify developing risks and trends in the financial markets” – does not have anyone running the Office of Data & Data Analytics.  How the hell is the Division supposed to do its job if there’s no one analyzing data?!?!?

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Volcker Rule? What Volcker Rule?

"Nothing illegal to see here..."

The FT reports that the Financial Stability Oversight Council is planning to adopt a tiered approach to the proposed “Volcker Rule” that originally sought to limit Banks’ proprietary trading activities (based upon the proposition that they’re inherently riskier than Banks’ other operations…)

Alas, it looks like in practice whatever rules we end up with look like they’ll be about as effective as drug testing in the NFL. (Warning, sarcasm ahead, clearly marked so as to avoid confusion)

At least in theory, team staff/doctors/etc are supposed to “monitor” players who may be ‘using,’ and the league conducts “surprise” and “reasonable cause” drug tests.  Of course its no secret that these “surprises” are a complete and utter joke, at best.  The NFL has quite an extensive list of “Banned Substances” and policies governing their illegal use (and masking thereof),  how players are to be tested to make sure they are not using them.  Test positive for a banned performance-enhancing substance once (and lose your appeal): 4-game unpaid suspension (from a 16-game season).  2nd time? 8-game unpaid suspension.  3rd strike: 12-months.  Seems like little more than increasingly-annoying slaps on the wrist, no?

Similarly, the FT claims that under the new, grossly-watered-down version of the remnants of the Volcker Rule, banks will have guidance on activities that should signal alarms or  flags in their internal control systems.  The next step (if the activity is deemed to be deserving of further scrutiny, a determination I’m sure will be honest and diligent…) is to have Bank risk managers/compliance interview the trader(s) involved.  As history has shown, fear of being probed by borderline mid-office personnel will no-doubt be more than enough to dissuade rainmaker traders from pushing the envelope…

Next, on the highly likely chance any “questionable” activities get past this point, regulators stationed on-premises at Banks (and presumably other regulated entities?) would be able to review the information surrounding the activity.  Considering how resource-constrained (and according to some, ineffective) the current large-scale financial regulatory apparatus is now, I’m not quite sure this “last line of defense” is realistic, let alone confidence-inspiring.  The FT continues:

William Silber, a New York University professor who is a trading expert, said a multi-tiered test would make sense if coupled with surprise visits to trading desks by regulators.

“Spot checks by regulators should be part of the package. Regulators should make sure traders know they are not waiting to act until after the cow is out of the barn,” he said.

Even if, as this NYU professor suggests, traders (banks) are subject – like NFL players – to random spot-checks, what’s to make anyone think such “random” inspections will 1. come as a surprise to traders and/or 2. uncover any prohibited activities and most importantly, 3. upon uncovering prohibited activities, result in sufficient punishments to discourage future acts?  Before Brian Cushing tested positive (and received a relative slap on the wrist for his BS excuse), when was the last time a massive, jacked-up NFL player was punished for using/abusing performance-enhancing drugs?

I wont proclaim to know for certain whether performance-enhancing drug use in the NFL is commonplace and the League, Coaches, Owners, etc simply “accept” it as that’s not what I’m trying to discuss (nor am I nearly informed enough besides what I see with my own eyes on Sundays).

In the aftermath of the Financial Crisis (or as some would say the darkest days thereof), Government officials promised they’d reign-in Wall Street’s society-endangering excesses and make sure that a greedy few couldn’t get fantastically rich by effectively playing with “taxpayer” money.  Now, what do we get?  More Wall Street-influenced, watered-down regulation that will likely fly under the radar of The Public (now more concerned about the new season of Jersey Shore or whatever Housewives show is currently en vogue), much to my chagrin.

The more things change, the more they stay the same.  Such certainly seems to be the case when it comes to Financial Regulation, at least.

Weekend Open Thread: How SHOULD a "Sophisticated Investor" Be Defined?

Securities laws define an “accredited investor” like this.  There are so many problems with these definitions I don’t even really know where to start, but firstly, I think the most glaring problem with the existing definition of a “sophisticated investor” is the wealth aspect.  Wealth does not equal, approximate, or even remotely correlate with financial sophistication.

What else needs to be changed?  Should we require at least a Bachelor’s degree in Finance?  Masters?  PhD?  X years of professional experience?  Lets talk this out and draft what we think it should really be.  GO!

Guest Post: Quote From Colonel L. Blankfein Jessup Before a Commission of Inquiry

From 1-2 aka @onetwoko

“You want the truth? You can’t handle the truth. Son, we live in a
country with an investment gap. And that gap needs to be filled by men with money. Who’s gonna do it? You? You, Middle Class Consumer?

Goldman Sachs has a greater responsibility than you can possibly fathom.

You weep for Lehman and you curse derivatives. You have that luxury.
You have the luxury of not knowing what we know: that Lehman’s death, while tragic, probably saved the financial system. And that Goldman’s existence, while grotesque and incomprehensible to you, saves pension
funds.

You don’t want the truth. Because deep down, in places you don’t talk about at parties, you want us to fill that investment gap. You need us to fill that gap.

“We use words like credit default swaps, collateralized debt obligation, and securitization… We use these words as the backbone of a life spent investing in something. You use ‘em as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it!

We’d rather you just said thank you and paid your taxes on time.

Otherwise, we suggest you get an account and start trading. Either way, we don’t give a damn what you think you’re entitled to!”