Receiving Wide Coverage ...
ClusterSwap: European banks are even more exposed to the risk of government defaults than you think. According to a story in today's Journal, regulatory data released last week shows these institutions have been big writers of credit default swaps on government bonds of the continent's dodgier countries. And it's not just investment-banking-heavy multinationals like Barclays and Deutsche Bank that have been selling this insurance; smaller European institutions, like Landesbank Baden-Wurttemberg in Germany, have also been taking sovereign credit risk this way. Granted, CDS sellers typically hedge this risk by buying CDS on the same bonds. But as we've learned from the recent discussion of "gross" versus "net" exposure, those hedges are only as good as the counterparties behind them. And by and large the CDS-seller European banks appear to have bought their offsetting hedges from, well, other European banks. It is somewhat reassuring, though, to read this bit in the Journal story: "Some big banks … say they buy only from banks outside the countries in which they are seeking protection"; for example, "Deutsche Bank wouldn't buy Italian swaps from an Italian bank." No bank would do anything that foolish … right? Also in the Journal, the "Heard on the Street" column notes that the cost of a swap insuring against a default by Bank of America is higher now than it was in the dark days of early 2009. Moreover, there isn't as much difference between the cost of insuring B of A's senior and subordinated debt as there was then. These developments, the column says, suggest the market now believes two things: that the U.S. of A is less likely to stand behind B of A should the bank falter; and that regulators could well exercise their new resolution powers under the Dodd-Frank Act to wind down a giant institution, a scenario in which senior bondholders stand to lose money. Bottom line: "Investors aren't so sure 'too-big-to-fail' banks will always deserve that moniker." Lastly on the topic of CDS: it ain't exactly the smoothest five pages of text we ever read, but a new report by Nicholas Vause, a senior economist at the Bank of International Settlements, is worth the time. Data from June 2011, Vause writes, suggests that derivatives dealers have been transferring "multi-name credit risk" (the CDS market's equivalent of index funds, roughly speaking) to shadow banks (a broad category that includes insurance companies, pension funds and money market mutual funds, all of which lack the same public backstops and supervision of traditional banks). "These types of CDS can be difficult to value and have experienced significant price jumps in the past" (never a good thing if you've been a seller). Morning Scan translation: there may be more AIG-style blow-ups waiting to happen out there. Underscoring the aforementioned concerns about counterparty risk, Vause also writes that banks and security dealers have been net sellers of credit protection on financial-sector debt. "The risk of simultaneous default of protection sellers and reference entities is often higher when these institutions come from a common sector, rather than different sectors. As the financial sector is broad, however, this risk could have been mitigated by careful pairing of reference entities with counterparties." Morning Scan translation: let's just hope no one bought insurance against default by an Italian bank from another Italian bank. Or the same one.
The European Rescue Plan: We don't want to get lost in a vortex of European political intrigue, and we're guessing you don't want to, either. So we'll try to be selective in what we include here on the agreement reached late last week in Brussels. According to the Journal, the Obama administration, worried the European debt crisis will spread, was disappointed the talks didn't result in a stronger bailout fund and is pressing America's allies across the pond to do more to stabilize the euro-zone. Another Journal story says a key question is whether the European Central Bank - "the one institution [people] believe can halt the euro-zone's downward debt spiral" - will step up purchases of Italian and Spanish bonds now that the region's leaders have agreed to stronger fiscal discipline. "DealBook" in the Times previews a report due out Monday - again from the BIS - that surveys the funding challenges facing European banks during the ongoing sovereign debt crisis. And another Times story explores the question of whether U.K. Prime Minister David Cameron helped or hurt his country's financial industry by refusing to take part in the accord. Cameron wanted to protect "the City" (London's equivalent of Wall Street) from potential adverse regulations. But by keeping Britain out of the new fiscal union, he may have cost his country a chance to influence European Union financial regulatory policy over the longer term, his critics say. "Our entire relationship with the member states of the EU, along with our capacity to shape policies that may influence a far higher share of our GDP, has been put at risk," wrote columnist Will Hutton in The Guardian. "The capacity to defend [the U.K. financial sector] has been thrown away. As an act of self-defeating, crass stupidity, this has rarely been equalled in British foreign policy." If Hutton and others are right, it stands to reason that pulling out of Basel III would be a really bad move for the U.S., no matter what Jamie Dimon says. One more Times piece reports that the European crisis is forcing traders and analysts in the U.S. to wake at ungodly hours to read the headlines out of Europe to prepare for the New York trading session. We at the Morning Scan can empathize.
MF Global: The Times has a lengthy, how-Icarus-flew-too-close-to-the-sun style investigative feature about Jon Corzine's ill-fated tenure at the now-kaput brokerage firm. Aside from vivid details ("Corzine compulsively traded for the firm on his BlackBerry during meetings, sometimes dashing out to check on the markets"), the piece also notes that his infamous $6 billion bet on European debt was actually profitable. Nevertheless, "fears about the firm's exposure to Europe tipped an anxious market, causing a run on MF Global that regulators suspect led the firm to fight for its life using customer money." Speaking of which, Times columnist James B. Stewart takes a step back and observes that until MF Global's demise, it was "unthinkable" that a brokerage's customers would be at risk of losing their money if the brokerage itself collapsed. Even Lehman Brothers' client funds were "safely segregated"; that this apparently wasn't the case at MF Global highlights one of the drawbacks of the self-regulation schemes in the securities and commodity industries. Meanwhile, the search for the missing money goes on. The lawyer of the trustee liquidating MF Global said at a hearing Friday that his client "has spotted suspicious trades in customer accounts that appear connected to a $1.2 billion shortfall." According to the lawyer, "most of the transactions appeared to have taken place close to the weekend before MF Global filed for bankruptcy."
Wall Street Journal
"I'm OK, you're in default." A Journal profile of Ocwen Financial - which is fast becoming the top specialty servicer of subprime mortgages through acquisitions of rivals - highlights the company's use of social psychologists to write the scripts for its phone reps. "As they talk to borrowers, workers are fed bits of dialogue by a computer program that tracks homeowner responses. As part of a current project, psychologists are parsing the words borrowers use for clues to their emotional and intellectual states." Cue the inevitable comment from a Journal reader: "I could have used one of those psychologists when I got the letter saying Ocwen was increasing our mortgage payment $777.27 a month for escrow we didn't owe."
New York Times
"When the Fed's policy-making committee convenes on Tuesday, it will consider the idea of publishing a regular forecast of its future decisions on interest rates." Such a forecast, if introduced soon, could lower long-term interest rates, and thus the costs of products like mortgages, "if it shows that the committee expects rates to remain near zero beyond mid-2013."
Columnist Gretchen Morgenson looks at the latest in who is fighting against "too big to fail," including Richard W. Fisher, president of the Federal Reserve Bank of Dallas, who draws a parallel to the nation's obesity epidemic.
An article by NPR's Adam Davidson in the Sunday Times magazine laments the oligopolistic nature of U.S. banking and the shortage of Google-like disruptors. To the extent that there are "ambitious newcomers," the article suggests they're mostly in "high-risk, high-loss products" like Direxion Russell 1000 Financials Bearish 3X ETF, or FAZ, a highly volatile exchange-traded fund tied to U.S. financial stocks. More "banking upstarts" are needed to offer "sensible things that the rest of us might want," Davidson writes. Has he been to Finovate?