Friday, February 26, 2010

The EU Is Shocked—Shocked I Tell You!

Janet Tavakoli emails:
Speaking of faltering economies, while Ben Bernanke and Chris Dodd are investigating transactions that destabilize countries, they should open investigations into the massive number of phoney securitizations issued by U.S. investment banking firms that helped destabilize the U.S. economy in recent years and contributed to the woes of the global economy. They might look into the derivatives transactions, too. They seem determined to ignore the blindingly obvious at home.

With respect to the EU, there are separate issues involving 1) the original legal asset securitizations for EU countries and 2) the current use of market instruments for hedging and speculation. The appropriate questions should be directed to the business purposes of the transactions.

The EU is shocked—shocked I tell you!—that weaker members used legal financial engineering to qualify for admission. Exactly how did they think these countries managed to meet the requirements? Leaders would have you believe they lack basic human curiosity. Countries may or may not have had legitimate plans to employ the present value of future receivables for a purpose that could generate better returns as opposed to say, blowing it all on national bling. In some cases, using the national credit card (backed by future receivables) may have been a futile attempt to appear prosperous enough to keep up with the Joneses. In a faltering global economy, the pain would be inevitable.

The financial media reports that sovereign credit derivatives are a fraction of the total debt issued. While that is true, it doesn’t take much to start a run on a country, because trading on the margin sets the price. Chairman Bernanke is right to question all related transactions, not just derivatives. The issue is the business purpose. While banks may want to claim they are doing customer business, one should remember that Goldman Sachs claimed its destabilizing transactions with AIG were “customer business.” How did that work out?
Tavakoli also told Canada's Globe & Mail that:

...she doubted anything concrete would emerge from the Fed's scrutiny of such instruments.

The problem with swaps, she said, is that they can create a loop of negative consequences for the country involved. Such swaps are a cheap and easy way for investors to bet that a country's finances will deteriorate. As the demand for such instruments rises, that sends a negative signal to the bond market, where investors become inclined to sell the country's debt, sending its borrowing costs higher. As the cost of borrowing rises, it adds to worries about a country's creditworthiness, increasing appetite for the swaps.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009). .

1 comment:

  1. Tavakoli is barking up the wrong tree on this one. She says:"The EU is shocked—shocked I tell you!—that weaker members used legal financial engineering to qualify for admission."

    This simply means there is no honor among thieves.

    Suggesting the FED or congress should investigate the "business purpose" of governments issuing swaps or derivatives would be like asking Al Capone to investigate the "business purpose" of the Valentines Day massacre.

    There isn't any!! There is nothing wrong with swaps and derivatives in and of themselves. But whenever government raises money thru any financial instrument it is with the understanding that tax receipts will pay it back. And taxes are theft.

    This coercive intrusion into the financial market and distortion of the market where the money is spent is the problem both ethically and pactically. It is the basis for the business cycle. Miss T. needs to read Wood's book!