Swiss Name 8 Banks in Forex Manipulation Probe

Some expected names, but a couple of surprises when the the Swiss Competition Commission named the 8 banks under scrutiny relating to potential forex manipulation.  This comes, of course, on top of industry nervousness and concern over the scope of investigations, potential manipulation and, most of all, potential penalties and damages to be paid to regulators and law suit settlements.  

Given the global scope of the investigations, with even jurisdictions like New Zealand getting involved, the smart money should be betting that this will need more time to play out before we can start putting estimates of dollars and cents on the fix.

How complex are banks? Let us count the ways.

Researchers at the Federal Reserve just published research providing measures on the complexity of banks based on Organization, Business Lines and Business Practice.  They provide some interesting charts that I've attached here.

You can check out the research and the report by going to the Fed's website here.

UK: 9 US: 8 / Keeping score in the LIBOR prosecutions

Bloomberg News reported today that additional ex-ICAP brokers will be charged by the UK Serious Fraud Office for alleged LIBOR manipulation, bringing the total criminal charges in the UK to 9.  This compares with 8 charged by the US Department of Justice.

US Attorney General Eric Holder stated last year that LIBOR prosecutions are a top priority for the DOJ but many writers and commentators, including Judge Rakoff, have questioned the lack of prosecution of senior finance executives over the financial crisis.  While the alleged LIBOR manipulation is not generally thought of as being a cause or contributor of the financial crisis, it did occur during the same time and also falls under white collar financial crimes.  Not that we're keeping score, but folks will be watching to see how the DOJ performs in prosecuting LIBOR.  

Law Firms Hired in Alleged FX Rate Manipulation Cases

This week Legal Week reported the names of the law firms representing various major banks and representing some of the plaintiffs, mostly pension funds, in many of the lawsuits that have been filed to date alleging foreign exchange rate manipulation by the banks.  Many of the suits have been consolidated into a class action lawsuit.

What did the BOE Know about the FX Fix? also, WM Reuters Says ... No Imminent Changes

BOE weather report is cloudy.  While BOE Governor Carney said last week that discussions before 2013 only referred to non-bank players potentially trying to manipulate the fix,  now Reuters reports that there are transcripts from chatrooms in 2012 where traders claimed that at a meeting the BOE agreed that there were advantages to banks sharing information on client fix orders.  The BOE originally said that minutes of the meeting involved were not prepared until June 2013, but subsequent searches by the BOE found emails indicating the minutes were circulated in July 2012.  And of course the BOE's suspension of an employee relating to this case muddies the waters further as to what the BOE knew and when regarding fx bank practices around the fix.

WM Reuters responded to an FT article last week that indicated that substantial changes to the fix would be coming shortly.  In a Reuters report the WM Reuters company said that in the FT article "words (such as) 'planning' and 'overhaul' are wrong. It makes it sound like there is something imminent happening and there is not."

UBS Announces Internal Investigation into Precious Metals Trading

The UBS annual report released Friday mentioned this as an outgrowth of their earlier begun FX investigation.  A couple of interesting points:

1) The mainstream reports over the last year have referred to alleged gold price fix manipulation.  Only 5 banks are involved in the benchmark rate setting process, and UBS is not one of them.  Goldbugs, on the other hand, have screamed market manipulation (by banks holding down the price of gold) for years.  While we are not gold market mavens, it appears difficult to believe that a long term strategy to hold down the market price of a commodity can be successful.  However, if any manipulation is found at all, we can expect many more conspiracy theories to see the light of day (and manipulation reports over the last few years will make them all a bit more believable).

2) Since the LIBOR scandal, UBS has developed a reputation of being the first bank to investigate allegations of wrongdoing and the first to approach regulators when anything untoward is found, trying to reduce or eliminate penalties.  Thus, this raises the question if once again, UBS is an early mover and additional precious metal trading investigations are to be begun.

Government Motors .... Just Wondering

     General Motors (GM) is in the news these days for safety issues surrounding an ignition defect "now linked to 12 deaths and at least 31 accidents over the past decade."  GM first reported publicly its own safety investigation and recall last month (February 2014), though there have been lawsuits over the years for several of the accidents.

    While we have no opinion on GM culpability and believe it prudent to wait for results of Congressional inquiries and other external and internal investigations, we wonder what it means that the U.S. government owned General Motors for a substantial and critical time period in this tragic story.

    The government injected $49.5 billion into GM in 2009 as part of the automaker's bankruptcy.  As a result, the U.S. owned 61% of GM.  Simply put, the government bought and owned General Motors.  The government reduced its position to 26% in late 2010, reduced again to 19% in late 2012, and sold down to ZERO in DECEMBER 2013.

    Now let's look at GM's chronology of its internal investigation thus far.  In the years 2005, 2006, 2007, 2011, 2012, and 2013 there were important developments and milestones in GM's findings and research into the ignition defect.  The U.S. government was the largest owner of GM in three of these critical years.  Of course, the government was also 61% majority owner for a period in which tragic car accidents continued.



CORPORATE GOVERNANCE

                                              SHAREHOLDER RESPONSIBILITY

                                                                                                            SECURITIES LAWS

We pose a few obvious, but interesting, questions:

*    What is the role of the Board of Directors?  Did the GM Board discuss the ignition defect safety investigation over the years?  In particular, did the Board members - including those installed by the U.S. government - perform their fiduciary and ethical responsibilities?

*    What is the responsibility of the U.S. government in its role as majority owner (2009-2010) and then dominant owner (2010-2013)?

*     As majority owner and dominant owner, did the government disclose all it knew about the evolving internal investigation as it sold large chunks of equity to the public?

*    Is the timing of GM's public announcement (February 2014) of this high-profile safety defect soon after the U.S. government's sale of its last holding in the company (December 2013) purely coincidental?

Reports on Rate Rigging Regulator Investigations just within the Last Week

The BOE oversight committee for the governing board announced that a London lawyer was appointed to head the investigation into whether BOE staff ignored or colluded with the alleged bank FX WM Reuters fix rate manipulations.

The Fed released minutes from the FX Committee in September 2012 discussing that the FED looked into the role that FX fixes played in the market, several months before others regulators began investigating the fix. It is unclear if the FED knew about potential manipulation, but took no public action.

The Bank of Canada is now investigating whether there has been any manipulation of the Canadian dollar fixings set by the BOC.  Similar to the WM Reuters fix, these fixes are set based upon actual trades during a very brief period.

The Hong Kong Market Authority (Hong Kong's defacto central bank) investigated HIBOR interest rate benchmarks for one year but found no manipulation.

The FDIC filed a lawsuit against 15 banks plus the British Bankers Association over LIBOR manipulation harming 38 US banks taken over by FDIC.  The FDIC is seeking damages for losses incurred, punitive damages and damages for antitrust violations.

Clearly benchmark investigations will continue to keep regulators busy around the world.  Unfortunately, investors must continue to wait to find out what occurred and if there are changes that need to be made to protect them.

Dumbest Trade in the World .... to be Guaranteed by the U.S. Government :-(

"Borrow Short / Lend Long" - let's call it BSLL.  This is an ancient and finely tuned scheme to lose lots of money in a flash.

BSLL has much in common with the Ponzi Scheme.  They both have deep roots in the optimism, opportunism, and gullibility of human nature.

Before Lehman Brothers and Bear Stearns, headline victims of BSLL have included the hedge fund Long Term Capital Management (LTCM) and Bob Citron's Orange County (California) Investment Pool.

On Wall Street, there's a different name for BSLL:  "Banking"

Today's Bloomberg reports that a class of repurchase ("repo") transactions may soon be guaranteed by a to-be-named-later guarantor which we say ultimately would be the Fed / Government.

Enough with the glib thumbnails, here are specific points:

• Collateral to be guaranteed (initially) is Treasuries and agencies.  Lehman and Bear did not fail due to Treasuries and agencies (though there's a different story of Bear and agencies).
• The real BSLL problem with repo is the inclusion of potentially illiquid collateral (everything other than Treasuries and agencies).  Simple solution:  the Lehmans and Bears of the world should fund illiquid assets with longer term borrowing.  Regulators can force that discipline on banks (by fiat or through larger haircuts, for example) if they wish.
• In "real world" repo trades with illiquid collateral such as ABS and CDOs, the repo lenders (mutual funds and the like) don't pay attention to the collateral as they arguably should.  Instead of guaranteeing collateral, it would be both easier and equivalent for the Fed to simply guarantee the secured debt of the borrower (banks, hedge funds, etc).  Why go in that direction?  All segments of U.S. society have had enough of guarantees for banks.  Who would seriously propose guaranteeing hedge fund (repo) debt?!
• Why would the Fed ENCOURAGE BSLL by guaranteeing the trades?!  It's as if a young couple wants to buy a house with a loan that matures in a week.  The one-week loan is a "good deal" because the interest rate is lower than a 30-year mortgage and the couple assumes they can roll the loan each week at the same rate.  It's not at all clever to "roll the dice" every week.
• The concept of a guarantee of the repo trade is meaningless once one asks a few questions.  At what price is the guarantee?  The loan amount?  Is the guarantee on the collateral value only or also on the credit risk of the borrower?  If the former, the guarantee cost is huge.  If the latter, the guarantee cost entails a complicated credit derivative.
• Yes, we know that "all of banking" relies on BSLL.  But this doesn't make BSLL "good."  Rather, it explains why the banking system is so fragile.  Despite the protests of vested interests, it is entirely possible to reduce the risk of BSLL in banking.  The country does not need the Fed to INCREASE the risk.

Latest Allegation: Lloyds FX Trader Provides Tip to Client to Harm... Lloyds

The allegations in this Bloomberg article reach new lows for fx traders.  The story is that Lloyds had to sell a large amount of sterling for their own account.  A trader notified a favored client beforehand so that the client could make money "front running" Lloyds' order.  Not that allegations of collusion against clients' interests are acceptable, but the possibility that fx traders would harm their employers for self-enrichment (the article refers to getting future business from clients, learning about large trades in the future and maintaining relationships with other traders in the tight-knit trader community) raises the question of who was really running the trading desks - the traders or the banks?

Alleged activities in front of large orders, such as traders putting trades through their own accounts, notifying favored clients and traders at other banks so that those parties can front run the orders, if found to be true, may be a defense, albeit a weak one, for any banks found guilty of wrongdoing.  Any bank claims of being unaware of improper activity may now seem a bit more plausible.

BOE Governor Testifies Tomorrow; Will need to Defend the Bank's Integrity Regarding the FX Fix

The BOE Governor will testify before the UK Parliment's Treasury Committee tomorrow to defend the BOE in the wake of meeting minutes showing that there was knowledge within the BOE as early as 2006 of unusual trading around the 4PM London fix for foreign currencies.  At this point the BOE says that it is unaware of any collusion between traders and BOE staff, however, there are many questions regarding specifically what the BOE was told and why this information was not passed up the chain of command.

Assuming that lack of collusion holds up under internal BOE investigation, the most likely explanation of why no action was taken may have to do with the age old problem of coziness between the regulator and the regulated.  Examples have repeatedly come to light among utilities (gas, electric and pipelines), banks, insurance companies and when closely regulated in the US many years ago, the trucking and airline industries.

Too True to be Good?

China, really, who knows?  There are two points of view.  At the risk of over-simplification, they are:

SINOPHILE:  China is a huge resource of both labor and consumers.  The country's in a great growth spurt for modernization and productivity improvements.  The government seems to manage everything just right to maintain excellent economic growth year after year.  China didn't even pause for the Credit Crisis.

SINOPHOBE:  The ideas don't fly and the numbers don't add.  With no respect for intellectual property and a long trail of economic data reminiscent of Bernie Madoff's investment returns, the China story can only have an ugly ending.  Communism cannot beget the free flow of innovation, capital, risk, and prosperity.

With the recent news that the Chinese government has permitted the debt default of Chaori Solar, both the PHILEs and the PHOBEs have another data point.  The former will appreciate the increasing Westernization of the Chinese corporate market.  The latter will believe the dam is about to break to reveal to the world a deluge of negative financial tidings.

It's rhetorically convenient in an article of this type to stake out a position somewhere in the middle.  But no!  That's not how FinancialPests operate!  We've planted our flag in one of these camps.  Let us conclude with this quote from the GARP News article:

"[T]he ruling Communist Party has pledged to make the economy more productive by allowing market forces a bigger role."

Whether it's ideas that don't add, numbers that don't fly, or historians who don't believe what they're reading, something's not right here.  In agreement with Shakespeare, we say time will tell.  Give it ten years - to 2024, say.  The current "China Model" will prove itself false.

Asian Regulators Probing Reports of Oil Benchmark Manipulation

The Wall Street Journal reports that British Petroleum says that Asian regulators are probing potential oil benchmark rate manipulation, in addition to earlier reports of European and US regulators.

There are similarities to the claims in the FX markets where allegations involve major banks manipulating rates set by WM Reuters.  Here it is Platts that sets the benchmarks involved, and last year large oil companies and Platts were subject to unannounced inspections by EU regulators.  Reports are that Japanese and Korean regulators became involved within the last three months.

BP also reported that 15 class-action lawsuits have been filed in the US alleging manipulation and antitrust violations, including a case brought by oil traders.  A similar number of cases have been filed in the FX allegations.

Both the oil and FX stories continue to unfold with few hints of an early conclusion.

BOE FX Group Meeting Notes: FX Benchmark Rates and Concern on FX Options Discussed in 2006

While recent press reports indicated that FX dealers said that the BOE had discussed WM Reuters fix trading in 2012, BOE minutes and discussions from the BOE FX Chief dealers meetings just released confirm this. However,the minutes also include from a mid-2006 meeting that there was evidence of attempts to move the market during certain fix periods.  Meetings in 2008 and 2009 also included this topic.

In addition, earlier reports indicated that some of the regulatory FX investigations include a review of option trading, particularly the attempts to defend or breach particular FX spot rates.  The BOE meetings notes now show a discussion at a 2006 Group meeting that bank FX systems could be manipulated in such attempts.  (Certain option position values can be dramatically effected by a particular spot rate at a particular time).

Thus these two issues were discussed at BOE meetings.  Today the BOE suspended a staff member .  While mentioning that there was no evidence of collusion by BOE employees regarding these issues, it was hinted that the suspension may be related to not raising these issues with the next level of BOE authority. The BOE also reported that the last of the FX Chief Dealers Group meetings was held in February 2013.  A subsequent meeting was scheduled but never held.

This information indicates to us that the regulatory investigations into FX benchmark rates are continuing at full speed.  If, in addition, there were attempts to manipulate spot rates to impact option positions, that would seem a more complicated investigation with less certainty of exposing any manipulation even if it did occur. This would more likely involve individual market actors without as clear a goal as a daily published fixing.

Who Run the World? Rating agencies?!?!

Gizmodo went beyond their usual comfort zone and published this post about rating agencies and one (of the many) proposed solutions on how to rid the evil that is ratings.  In my years working in the capital markets I have heard many complaints about the rating agencies, but at the end of the day, investors rely on ratings. Why? Because they value the opinion of the agencies.  If they truly thought that ratings were completely broken, why do they still rely upon them?  As for the conflicts issue, well, nationalizing agencies only create more problems than resolve them. And if issuers are not supposed to pay, then that only leaves the investors. But guess who often complains about the possibly investors paying for ratings?  Investors. 

If You Are Fired Tomorrow ....

.... What Will Your Successor Do Differently?

In the mid-1980's Andy Grove was President of Intel and Gordon Moore was the CEO.  Intel had been losing money and market share for years in their core business of semiconductor memories.  The competition was winning.  Grove and Moore knew they could not turn it around but were afraid to admit it.  At the time, Intel was memories.  The core, culture, and success of Intel had been memories.

    Grove asked Moore:  "If we got kicked out and the Board brought in a new CEO, what do you think he would do?"  Moore's quick, no-need-for-thought answer was "he would get us out of memories."

    So that's what Grove and Moore did themselves.  Until they had played out this odd decision-making device, they did not realize consciously this right answer that would be immediately evident to an outsider.  One can take several lessons from this story.  The most direct lesson is to ask yourself, when confronted with a seemingly intractable business or personal challenge, what would an outsider with my knowledge but without my "invested capital" choose?

    We just finished reading Grove's Only the Paranoid Survive.  Though 16 years in the past, Grove's management advice and stories remain worthwhile.  We consider the excerpt above to be the best part.