Wednesday, 15 July 2009

World Bank volte-face on finance and development?

Oh to have been a mouse in the corner last Friday morning in the World Bank’s Finance and Private Sector research department! In a guest article for this week’s The Economist, World Bank chief economist Justin Yifu Lin argued that “small, local banks” are the best entities for providing financial services in developing countries where SMEs are critical to growth.

Not ground-breaking stuff you might say. Heterodox economists have been making this point for years. Developing both relations with local businesspeople and project assessment skills are critical if local banks are to support the development process. Big international banks tend to cherry pick large corporate clients, and use their technological advantage in credit scoring to rapidly increase household indebtedness (witness Mexico).

But the Lin article takes on more importance in the context of nearly two decades of Bank research and policy advice which has advocated a position contrary to his own. From Clarke et al. (2001) (‘Foreign bank penetration improves financing conditions for enterprises of all sizes’) to the much-cited Claessens et al. (2001) to Beck et al. (2003) (‘a larger share of foreign-owned banks removes financing obstacles’), and much more beyond, the Bank has been a cheerleader for the benefits of big banks in little countries.

Moreover, the Bank’s private sector arm, the IFC, has eagerly supported the development of loan securitisation, mortgage-backed securities, collateralised debt obligations and originate-and-distribute banking models (dos Santos, 2008) - hardly the “simple banking systems” whose merits Lin extols.

(Lin also praises Japan, South Korea and China for resisting the rush to prematurely develop stock markets or integrate into international financial networks. Again, not new (Ajit Singh has made this case for over two decades), but decidedly against the World Bank flow.)

Could this be a portent of good things to come at the Bank? Or will Lin be slapped down by Wall Street via the US Treasury (a la Stiglitz) or quietly sidelined (cf. Bourguignon’s inequality agenda)? Perhaps Lin’s carefully chosen words later in the article (‘small, private domestic banks’) will have been just enough to avoid rocking the boat. After all, HSBC is the ‘world’s local bank’…

(nb. I’m not the only one to be struck by Lin’s editorial – a vigorous debate of the great and the good, including several former Bank economists, has broken out on The Economist)

Monday, 13 July 2009

Head and Shoulders Update: Could this be a new definition of Financialisation?

So as I type the S&P is up around 2.5%, and the puts I was talking about earlier are now trading at .28 / 1.28 - so a massive loss so far if you bought them this afternoon... dooh.

So financial markets are up because Goldman Sachs took enourmous profits from trading in financial markets.... THIS is financialisation!

Head and Shoulders

Lots of talk in the last week or so of “head and shoulders”. Many markets are forming this legendary trading pattern and several mature markets have “broken the neckline” – meaning this could be the moment for the fall in equities that many predict. Moreover as this piece points out, the Vix is doing strange things with it’s moving averages.

It might be thought that this is the equivalent of reading coffee grains but if the game is to guess what everyone else is guessing about everyone else’s guesses … then why the hell not!

If we follow this then the stock market is not the result of an objective random news generator, the process of which analysts set out to discover, but rather an exercise in group psychology! If only it were that simple.

Talk has also re-surfaced of the dark forces of the Plunge Protection Team. This is the White House appointed team has the right to intervene and support US stock indices. Widely assumed to have been very active at the start of the crisis in an attempt to prevent the stock and housing bubble bursting at the same time. Their presence is most often invoked when quiet end of day trading on down days gets sudden boost, usually when Europe and Asia have gone home and volumes are thin. Wilder rumours also hint that certain insiders get tipped off, they presumably would then lend their weight to the rally and earn the profits of doing so. Who knows?! The political economy of the US certianly includes close ties between state and finance capital as the appointments and events of the crisis have shown.

In the coming week or so we have option expiries and earnings announcements. If financial proces are as arbitrary as the above isn’t it earnings that will bring them back in line with the forces of production? Well, not really when what really matters is i) where expectations have been managed to, and ii) what the companies tell us they are predicting for the future. So still a decent amount of guess work in there.

Once you start seeing head and shoulders it seems it’s rather catching and you start to see them everywhere... MacroMan sees one in the MSCI today although the neckline isn’t broken yet.

Today you could buy 850 strike, July expiry, S&P puts for $2.8 on igindex. This is a statement of fact not investment advice. As discussed, prices might go up, might go down, might be politically influenced, might not. Pretty arbitrary actually.

Monday, 6 July 2009

How the dead live...

You thought it was dead but it seems it's having another go-around. Securitisation is back, only this time it's better, smarter, safer... honestly! Barclays Capital are calling it "smart securitisation", Goldmans "Insurance". From what we can see it seems to follow the complicated formula: diversify, improve rating. Apparently this time it's ok though as the instruments are taking existing assets from bank's balance sheets not generating new ones. Well, my friends that's how securitisation started the first time around.

It seems similar moves are afoot in the market for Commercial Real estate Mortgage Backed Securities (CMBS). Here the incentive seems to be from S&P who are to downgrade a load of bonds such that they will no longer qualify for the FED's TALF liquidity facility. Not that anyone went anywhere near it the first time around - the banks need capital not liquidity. Instead the private side is constructing what they are calling "re-Remics". I quote Risk Magazine: "This involves splitting existing CMBS into new tranches with fresh ratings." (Who is buying this stuff?!). Crucially this "might also provide regulatory capital relief for banks and insurance companies". Well they won't be doing otherwise!! Groundhog day anyone? Let's go round again?

Lack of meaningful action by regulaltors is leading to private side innovation to fill the space they are creating, be it Sovereign CDS indices, re-Remics or whatever. The financial press at least this time around can see that this is somewhat peculiar, and understand the instruments better than previously (note the altered the phrasing around "ratings instability"). But on it goes never-the-less. Do we really want another go-around?

Friday, 3 July 2009

A Rolling Stone gathers no moss...

A few stories have caught the eye in the last week that potentially tell us a little about where derivatives / financial markets are going.

Firstly this week saw the launch of Indices for sovereign CDS. The Alphaville Blog post and comments really summarize this, in particular the first comment which begins, “This is a pointless punting instrument”.
- What exactly could you hedge with this?
- Who would you buy the hedge from?
- Which currency would you denominate it in?
In short this is a very awkward hedging tool and a very useful trading / speculating tool.

If that is the private side response to the current situation the public one is not too dissimilar. The US and others are still calling for more standardized derivatives as a key part of the regulatory overhaul. Indeed we have seen standard CDS coupons put in place in the US and in Europe.
- Does standardisation bring derivatives closer to production, giving capitalists a risk management tool to help them manage their specific business risks? NO.
- Does standardization help those that want to trade vast volumes of derivatives? YES
- Does standardization and large volume trading help speculators? YES
- Does anyone still think that the problem with CDS pre-crisis was not enough volume? That price efficiency will follow if we can just make the market ‘purer’? SURELY NOT!?

Finally, in the same vein of financial instruments divorcing further from production and becoming simply investment vehicles Bloomberg noted that correlation between asset classes is at all time highs. “The Standard & Poor’s 500 Index … is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds.”

The fact of ever increasing numbers of asset prices moving in lockstep would be consistent with the rise of anything and everything as an investment vehicle. Now the forces of supply and demand for the investment outstrip the forces of demand and supply from production. Herd mentality, risk aversion and so on rule the roost (incidentally, fear is often said to manifest itself in the VIX another abstractr index; Macro Man notes “for the first time in quite a while, the ambient temperature in SE England is higher, in degrees Celsius, than the VIX.” – a vital technical???)

Why does this matter? Well first of all the alleged benefits of derivatives and financial markets are risk sharing, hedging and so on. Surely these are best served if derivatives move towards and not away from production, become more hedger friendly not less. Secondly the further from production the more fictitious financial prices become and the more open to herd behavior, bubbles and outright manipulation. This leaves financial capitalists in the position we find them now of trading the hell out of the markets as they rise and resisting the fall by either getting out at the top or using their political clout to avoid the consequences.

Which leads finally to a piece in Rolling Stone magazine highlighting the activities of those Masters of the Universe, Goldman Sachs. It shows in irreverent language but damning detail how bankers inflated and rode the dot com, the housing and the oil bubbles, have come out of the crisis bailout as shiny as ever and how they are now looking at global warming, carbon markets and the rest as the new “asset class”.