Blowing Our Own Horn

ESADE´s MBA Finance Lab has been up and running for six months now. We´ve done quite a lot. Much of it good I hope, most of it useful I believe, all of it extremely practical-relevant I am sure. This is quite an innovation, and we should applaud ESADE´s willingness to embrace new things in pursuit of better services for its MBA students. Not many other high-ranked b-schools offer MBAs this kind of intensive advanced financial training from day one (just to give you an example, our very first seminar in the early days of September touched upon the role of mathematical models in the financial crisis, a decidedly non-simple and inescapably top-of-the-agenda topic).

Y1 MBAs participating in the Lab have now received detailed exposure to key advanced topics such as Basel Bank Capital Rules, Bank Leverage, Derivatives Trading, the Euro Debt Crisis, Credit Default Swaps, Risk Management for M&A, Weather Insurance, Volatility, plus workshops on some of the basics and a few guest speakers. In the next three months we will add new topics to our seminars (very relevant themes relating to capital markets or asset management for instance) on top of another new in-depth elective course.

The above can be a wonderful complement to the introductory financial analysis and corporate finance courses offered in parallel as part of the MBA core. The aim is to have MBA students with a way-beyond-average exposure to financial things by the time the summer arrives. After that, and armed with this fruitful intensive initial nine-month experience, they can (and are encouraged to) further satisfy their hunger for finance education through the many standard specialized electives in offer for Y2.

I am highlighting all this as a way to illustrate ESADE´s capacity for inventiveness. Through initiatives such as this, students receive very relevant knowledge way before it´s typical in the typical program. This should give them solid ground for early job interviews, for further finance study at ESADE, and for discovering hitherto ignored sectors within the finance industry. In all, not a bad development.

In contrast to many other schools, ESADE is characterized by its commitment to a varied academic menu, offering potential students lots of enticing programs to choose from. The MBA Labs honor that tradition by focusing on student needs and expanding the range of valuable opportunities within our walls.

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Hello Basel III

Few things in finance/economics/society these days are more important than the health of the banking industry.
Nothing is more important for the health of the banking industry than bank capital.
Bank capital is regulated (minimum amount).
The Basel Committee is such regulator.
Basel mandarins have the power to dictate how much capital (how much leverage) banks hold (enjoy).
The 2007-2008 crisis was a crisis of too litte capital-too much leverage.
So-called Basel I-1.5-II failed miserably at calculating and enforcing capital requirements.
As a response to said disaster, Basel III was proposed. In theory, it should lead to more and better capitalized banks. Plus new liquidity requirements, etc.
Basel III just came alive, this week.
But (a very big but) not in the US/EU. At the request of banks (and some politicians/regulators who actually don´t trust that Basel III is stringent enough), the most important financial centers have been allowed to delay implementation of the new rules.
Basel III is alive in India-China-Saudi-Mexico, but not in US/EU.
So the biggest banks effectively continue to abide by the same capital demands in place before (that led to) the cataclysm.
These delays may be “indefinite” (i.e., bye bye Base III).
Should we be concerned, very concerned?

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The Unstoppable Rise of the Meaningless Financial Metric

Why should we care about the ongoing Libor manipulation scandal? Well, there are several reasons why several individuals may have very direct concerns. Some derivatives counterparts to Libor-setting banks may have suffered losses as a result of the manipulating. These counterparts could include not just buccaneering hedge funds but rather more sensitive players such as governments or non-financial corporates. Some borrowers may have suffered larger funding costs, and this too could be a sensitive zone as it would involve average people repaying a mortgage or a student loan (though, admittedly, the artificial Libor tweaking could as well have resulted in lower costs for those retail customers).
But besides specific nit-picking, there is a more overarching, more general cause for concern. Bluntly stated, we are now in a deep state of confusion as to what Libor and its overseas siblings really mean. They used to represent the average interbank unsecured funding rate, once top and bottom bank submissions are disregarded. As such, these metrics provided pretty useful information as to the state of the ever so relevant interbank lending market. More so given that one can see each bank´s individual submission to the setting panel. Libor was a wonderful thing because it provided tons of transparency as to a key variable, and could thus act as trustworthy benchmark for a myriad of rates-based transactions worldwide. If you made a bet for or against Libor, or if you swapped your fixed funding cost for the more variable Libor, you were supposed to have grounds for a reasonable assessment of the future cashflows that you would be entitled to or liable for: as true interbank lending rates would go, so would the outcome of your trade.
It should be clear now that that´s not necessarily the case. Libor and its siblings won´t necessarily represent real rates, but rather the rates that can make certain traders inside certain banks particularly happy at a given point in time. And such flaky figure is much harder to estimate and ascertain. Much harder to bet for or against. Much harder to rely on as a borrower. The precise Libor number was always going to be hard to gauge beforehand, but its direction (upwards or downwards, by a lot or by a little) could be much more accurately guessed by those in the habit of following and analyzing economic developments. A corporate treasurer could make an informed decision as to whether paying fixed or floating for a five year loan made more or less sense. But that was when Libor was supposed to stand for Libor. If Libor instead is shown to stand for “whatever trader A at bank B and trader C at bank D need it to be to satisfy their impossible-to-know temporary narrow interests” then the decision making process becomes much more clouded. So much in fact that Libor may be completely forgone as a reference.
The unbearable loss of faith in Libor is but the latest episode in a saga that has seen many of the most sacred financial variables revealed as devoid of precise meaning. We had for decades been told that those variables meant something which they clearly do not. The crisis that began in mid-2007 has firmly demolished our belief in hitherto sacred beacons. Value at Risk, which was always supposed to represent a reliable guide as to a bank´s market risks and which practical relevance is second to none, has been definitely unveiled as a big liar; its outputs are in fact utterly untrustworthy. Credit ratings, equally traditionally worshipped and equally relevant, lost an insufferable amount of credibility as the most toxic assets ever devised were categorized as worry-free and as otherwise bankrupt nations were deemed gloriously safe; no longer can we trust AAA to stand for AAA. VIX, the very ubiquitous and widely followed “volatility” index that influences so many trading decisions, also tells a deceitful tale; it simply is not what we continue to be told it is, in effect allowing an undecipherable ghost to rule markets.
Having so many meaning-less influential variables roaming around is obviously a problem. It can lead to very distorted decisions, introducing untold amounts of noise and pushing naïve people towards the precipice. Can markets be navigated when their key variables are inscrutable and easily manipulable by unknown individuals with unknown motives? When all faith in erstwhile deified indicators is lost, and agnostic cynicism runs rampant, is it possible, even unadvisable, to keep rolling the financial dice?

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Bank Capital and the Crisis

In a fantastic example of intra-ESADE academic collaboration, I have just completed a trilogy of papers on the uber critical theme of bank capital regulation. Together with Vasiliki Kosmidou (who just graduated from the MSc in Finance program), we conducted in-depth empirical analysis of the types of regulatory capital requirements (Basel Committtee) that large international banks were facing on their trading activities before, during, and after the 2007-2008 crisis. Bluntly stated, these banks were running vast trading positions with essentially no capital (i.e. it was essentially all being financed via debt, and very short-term debt at that).
No wonder then that these institutions collapsed at once and very fast. If you have no capital and your assets sink just a bit, you are insolvent. Given how toxic many of those trading assets were, it is easy to appreciate how exposed the system was.
You can find the papers at http://www.esade.edu/ftmba/eng/academics/finance-lab/publications

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Why I Love Business Schools

What´s the central crisis/drama of our time? Bankrupt public sectors, the world over. State and municipal governments just overextended themselves, spent too much, borrowed too much, wasted too much. The impact of this was not neutral. An unaffordably overextended public sector has in the end implications for everyone: cut backs on promised services, higher tax rates, unpaid bills, financial contagion, tons of workers who may not be employable anywhere else, and overall social malaise.
While it´s hard to deny the need for a public sector, it´s equally hard not to fear the consequences of a wastefully bloated one. From Athens to California, from Lisbon to Buenos Aires the tale is the same: unmeetably huge public debt burdens, dragging down the place.
The importance of a healthy, wealth-creating private sector has thus never been more critical. And at the end of the day, taxes and debt backed by the prospect of taxes pay for state and municipal budgets. It´s as simple as this: if you want to afford a large public sector, and if you don´t want to have to make use of tools that may lead to Zimbabwean inflation, you need a healthy private sector.
Yet, so many young people want to avoid the private sector like the pest. The last poll I read said that up to 2/3s of Spaniard university students wanted a public sector job, perhaps assuming that someone somewhere will always find money to pay them.
Enter b-school students. MBAs, MSc, and the like. Here we have a group of youngsters from many different countries who have all (ok, almost all) voluntarily and eagerly decided to make the private sector their professional life. Heck, they are even borrowing a lot of to make that dream come true. Far from avoiding the private and seeking the public, they are willing to borrow up to 100-200k to guarantee a private sector existence. They are voluntarily and eagerly (fanatically, even) willing to be the ones funding the public sector, rather than be the ones being funded. Many are not even satisfied with joining an established private sector firm, they need to entrepreneurially create a new one from scratch.
B-schools are thus wonderful oasis in what can be a pretty deserted landscape. We need these MBAs and MSc to succeed. We need them to keep existing private sector firms afloat and prosperous and to invent new ones out of nothing (with the new jobs and wealth that that entails). Public sector staff should be cheering them on, as an innovative and growing economy can do wonders for tax collection.
MBAs and MSc should every morning look at themselves in the mirror and applaud themselves, congratulate themselves. Every morning. For they are among the courageous ones willing to go out there to preserve, create, and invent the wealth that keeps us all going.

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A Greek Victory (Right?)

So it´s still early to tell but reports indicate that Greece has successfully completed its 10 billion euros debt buyback. Local banks and international hedge funds appear to have taken up the offer with sufficient gusto. We won´t know the final figure until we get official confirmation, but the hope is again for a withdrawal of about 30 billion euros of old (well, new; these are the bonds issued as part of last March´s restructuring) debt. After this new round of debt shake-up, Greece will have almost no private sector creditors, being in the hook mostly with public sector bodies. This could be good news or bad news for the Hellenic Republic. Good because public creditors can show unlimited flexibility when it comes to friendly terms (once the buyback is confirmed, the bailout loans will automatically become much more accomodating and affordable for Greece; courtesy of its EZ pals). Less good because now private creditors feel crowded out and very junior, not the most enticing of encouragements for someone to buy your bonds (and keep in mind that Greece has not yet actually defaulted, at least according to the formal definitions).
What´s next? Greece post-buyout and its perks should be in a relieved position debt-servicing-wise. Public lenders could be rationally assumed to be willing to essentially transform their claims into perpetuities (the ultimate “can-kicking”). EZ taxpayers could be safely assumed not to be too aware of the technicalities of what´s going on and why Greece may never have to really repay them the more than 200 billion euros they are owed. I don´t think we´ll see German pensioners chasing Greek assets with the zeal and intensity of vulture hedge funds. Can we de facto proclaim that post-buyback Greece is a Greece with very little effective debt obligations? It may be a tad adventurous to say so, but perhaps it mayn´t.

Amid all this debt shenannigans, amid all the news inundated with haircuts, collective action clauses, net present value losses, and Dutch auctions, I for one would love to open the papers one day to the rather more inspiring and uplifting headline “Greek start-up company invents new revolutionary product, to be desired and purchased globally”

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We Cry For You Argentina

It´s Argentina versus the judges. After losing a flagship navy vessel upon the verdict of a Ghanaian court, the nation of the pampas is now at risk of losing a lot of money (or its good name in credit circles) upon the verdict of a New Yorkian court. The now world-famous judge Thomas Griesa has ordered Argentina to pay its so-called holdout bondholders in full before it repays what it owes those other creditors who in contrast chose to participate years ago in the country´s debt restructuring. That is, unless Argentina ponies up the full $1.3 billion claimed by those who refused to accept a haircut, it would not be allowed to pay a cent to anybody else (in the US, at least). This would constitute an instant default.
This has a Greek-ish ring to it, of course. Again, holdouts may end up getting paid 100 cents on the dollar while non-holdouts (“those fools!”) have to make do with 40, 30, 20 cents. Refusing to cooperate in a crucial restructuring and patiently holding on for a number of years (or mere days, as in the Hellenic case) appears to pay off. Not surprising, then, that similar players (Elliott Management) prominently show up in both cases.
An appeals court has for now supposedly ruled judge Griesa out. The globe breathlessly watches how this whole thing develops from now on. President Cristina Fernandez has publicly lambasted those “vultures” who actually want to get back everything they lent to Argentina, and has vowed never to pay them in full or at all.
Sovereign debt continues thus to rabidly front the headlines. Imagine a world where governments did no borrow (too much) money, how many less headaches that would cause?

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Greece buys itself (cheap)

Part 1546 of the Greek debt restructuring saga. Greece has made a formal bond buyback offer to its private creditors. A range of acceptable prices has been listed. Bondholders will place offers and those will be allocated via Dutch auction, up to 10 billion euros in total. Greece could end up reducing its debt pile by 30-40 billion euros, about 10-12% of the total. Once more, these tweakings are a requirement for receiving bail-out money (the next tranche of the second programme, in this case). The IMF was particularly insistent here.
So if you already took a 53,5% haircut in March and now sell those bonds at a 60-70% discount, you could end up getting paid well below 20 cents on the dollar in the end.
So why go for it? Well, liquidity. This is a chance to offload your Greek book at once and for prices above market levels. Could you really dispose of those positions in the open market, at those prices? Maybe, maybe not. Also you could wait it out and hope for the best, maybe Greece will pay you more than 40-30% on your bonds; but those mature after 10 years and for 20 years. Fancy your odds?

Finally, please stop accussing the maligned Troika of not helping out. The 10 billion euros for the buyback comes from bail-out fund short term securities used as payment medium. And Greece has been gifted all kinds of friendly treats: interest rates on the first bail-out have been restrospectively reduced (so that, for example, Spain now losses money lending to Greece), maturities have been exasperatingly extended, and a ten-year holiday on second-bail out interest payments has been granted.

This is in fact a massive writedown in disguise. For now, private investors get the short straw (the high hat, some may say). One wonders, is wiping out private creditors enough? Or will public lenders also need to be obliterated before Greece is officially deemed viable?

In the meantime, is anybody trying to create private sector jobs in the Hellenic Republic? You know, those that employ people who actually produce things and who can then pay taxes and export stuff abroad, so that the country may be less dependent on borrowing to survive. Call me naive if you want. I probably deserve it.

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Spain Is Not Greece (Right?)

Was invited the other day to a panel on Spain´s deleveraging process. Next to me were BBVA´s chief economist and S&P´s head for EMEA sovereign credit ratings. They both espoused optimistic messages: Spain will be ok. Shy that I am when it comes to domestic issues, I machiavellianly chose to muse on the recent Greek debt restructuring and what lessons it may hold for Spain. Greece, you may recall, imposed a 53.5% haircut on 97%+ of its private sector bondholders. Could the same thing happen in the country where I was born? The numbers here, needless to say, would be a tad more dramatic. Spain owes much more money than Greece, so investor losses could be significantly more painful. And not only on bonds: those who sold Spain protection via credit default swaps could also be fatally wounded (outstanding net Spain cds volume is four times what Greece´s was). A big haircut on Spainiard debt could cause ripples throughout markets, in particular when it comes to Euro sovereign debt.
None of my co-panelists believes that such a state of affairs will prsent itself. Spain, they argue, will not follow Greece into haircut-land. But let´s not forget that Greece had to impose haircuts as an inalterable pre-condition to receiving further EU aid. Should Spain finally submit to pressure and become the fourth Euro nation to request a comprehensive bailout, similar conditions may arise.
A haircut need not be a disaster, of course. In fact, it may be argued that investors (creditors) losses would be (should be?) a natural outcome of a crisis such as the current one. No big surprise there, no need for shock. What can be more debatable is whether only private investors should feel the dagger, or rather whether public creditors (the ECB and the like) should also incur setbacks. In the case of Greece, the latter were utterly spared, while the former were mercilessly subjugated.

Spain is not  Greece, but it´s nonetheless useful to understand what happened in the Hellenic Republic. Just in case.

 

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Warren Buffett´s big derivatives trade suffered almost no losses in Q3 2012

Mark-to-market (accounting) losses suffered during the quarter amounted to just $118 million, compared with $2,443 million a year earlier.
Those of you who attended the FL Seminar “The Big Short” may recall that Berkshire Hathaway (Mr Buffett´s firm) several years ago sold a ton of equity index put options and a ton of credit protection through credit default swaps. Buffett raised about $7 billion in premium upfront, which he most likely invested in the markets. He hopes that any eventual cash losses on his short derivatives positions will be more than compensated by the returns earned on those premiums (“float”, in the insurance jargon). Through the derivatives, Buffett is exposed to the folllowing risks: declining stockmarket prices, increasing stockmarket volatility, enhanced probability of credit problems, actual credit problems. Most of these derivatives have long maturity dates and Berkshire won´t have to make almost any cash payment (if at all) until those dates. Berkshire seems not to be beholden to its derivatives counterparties through collateral agreements, so temporary accounting losses would not transform into real losses.
While credit swaps recovered in value in Q3, the equity puts lost another $500 million in value.
Notional amount of the equity puts is $34 billion and that of the credit swaps is $15 billion. The current MTM liability for Berkshire is $10 billion.
Berkshire had total revenues of $117 billion in the first nine months of the year and net earnings of $10 billion.
Derivatives gain/losses go into earnings (these are not hedge products).
So Buffett´s big bet against the Black Swan has had an overall not so bad recent quarter. But, like any other derivatives shorty, he continues to expose his firm to the “rare” event making an appearance and blowing up those who dared challenge it.

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