Sunday, February 17, 2013

The New Wall Street: Lipstick on a Pig...

I spent the evening in the local mega-bookstore. In additional to learning about every other subject under the sun, I searched high and low for any confirmation that the global economy was in the least bit of jeopardy. I found scant evidence that there is the least bit to be concerned about. Apparently, everything that wasn't done after 2008, is still working out just fine. Oh right, until I came across this article in The Atlantic informing us that Wall Street is doing the exact same things, only under a different name...

Formerly "Proprietary Trading" i.e. gambling with bank equity.

Now Known as "Hedging" - as in massively increasing an offset leveraged position to the point where it dwarfs the nominal amount being hedged. It turns what is supposed to be a risk-reducing strategy into a risk amplifying and profit-seeking activity

Formerly "Derivatives Trading" i.e. massive highly illiquid private side bets made between large institutions (e.g. CDS from the subprime days).

Now called "Customer Accommodation" Wells Fargo has CA nominal exposure of $2.8 trillion . JP Morgan's CA nominal value is $72 trillion or ~5 times the size of the U.S. economy

When asked how much the bank could lose from this amount of risk. No one seemed to know...

Then the author describes three tiers of asset valuation:

1) Market based

2) Hypothetical Model based

3) Sci-Fi/Fantasy based (upstairs, next to the bathroom)

It turns out that most of Wells Fargo's assets are valued based on level (2) hypothetical models and are not mark to market.

Remember Special Purpose Entities (SPE) i.e. the off balance-sheet time bombs that blew up Enron?

These have now been renamed as VIE ("Variable Interest Entities"), presumably to protect the innocent.

Wells' Fargo's VIE exposure, is a mere $1.46 trillion or 10x its capital buffer

Just as after the highly publicized fiascos of the 1980s, when Wall Street conveniently renamed Leveraged Buyout (LBO) to Private Equity - despite the fact these deals still usually involve 10x as much debt as equity - clearly, after 2008 they did the same thing all over again i.e. changed the acronyms to fool stooge regulators and the general public.

I highly recommend reading the entire article, it lays to rest any notion that the banks are safer today than they were five years ago. The main difference between then and now, is that back then Wall Street had figured out a way to make money by shorting subprime (via CDS derivatives), so they were sounding the alarm on the prospect of making a killing when the subprime market collapsed. Today, Wall Street itself is now a major bagholder, all in on carry trades and risk assets, massively leveraged with Central Bank dopium, so there is no one sounding the alarm.