Reducing or displacing bank risk?

Daniel Davies d_squared_2002 at yahoo.co.uk
Thu Oct 26 03:01:37 PDT 2000


Socialising bank risk, more like. This bill looks like one of the more egregious bits of industry pork I've seen in a while. I've snipped out the crucial bits below; here's the spin.

Basically, this is more of a post-Barings bill than a post-LTCM one. The idea is that, in a big bank workout, it's often possible to find a buyer for the business. But, if there's a big derivatives book, the buyer will be worried, and often unwilling to take on what could be a massive concealed liability. So the derivatives book gets surgically removed from the rest of the bank in Chapter 11.

The fact is, though, that the final paragraph "derivatives are complex financial instruments ..." is bollocks. Derivatives aren't complicated at all. I've explained them to my gran. What makes derivatives positions hard to measure, is the fact that the book-keeping arrangements in most derivatives operations are somewhere between "inadequate" and "pathetic". Derivatives didn't bring down Barings and LTCM; the companies' inability to create a complete statement of their position quickly enough did. This bill is legitimating the shoddy practices of the industry and allowing the banks to maintain the fiction that it's all because of scary derivatives, rather than because they can't be bothered to run their books right.

The main effect of this legislation will be to shake the little players out of derivatives trading. If the derivs book isn't supported by the capital of the rest of the firm, counterparties are going to demand that companies set up separately capitalised entities to carry out their derivatives business. Folk like JP Morgan do this already anyway. But it's not economically viable for the more marginal players (I wonder how this will affect Henry Liu's franchise?).

hey ho hum, it's not interesting but at least it's true.

dd


>
> WASHINGTON (AP) _ The House passed a bill on Tuesday
> designed to reduce risk
> to the nation's banking system should a major
> financial institution become
> insolvent.
>
[snip]


> The legislation would allow a bank or investment
> firm in bankruptcy-court
> protection and its creditors to separate out the
> company's losses from
> derivatives trading, rather than have the trading
> contracts tied up in
> bankruptcy proceedings.

[snip]
>
> Derivatives are complex financial instruments whose
> value depends on the
> value or change in value of an underlying security,
>

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