Posts Tagged ‘Lehman’

Banks’ Alice-in-Wonderland Accounting

In Accounting, Banks on 28/10/2011 at 7:02 am

The problem with a bank’s balance sheet is that on the left side nothing’s right and on the right side nothing’s left.

Think Lehman’s and Dexia’s balance sheets. One day AAA, six months’s later rubbish. That fast leh?

Profit and loss accounts are just as rubbishy. Recently UBS’s third quater profit fell to 1.02 billion Swiss francs (US$1.2 billion) in the three months ended Sept. 30 from 1.66 billion francs in the period a year earlier. The trading loss of  1.85bn Swiss francs (alleged caused by a rogue trader) and charges linked to a cost-cutting plan were partly offset by an accounting gain on the bank’s own credit of 1.8 billion francs and the sale of some investments.

Now this accounting treatment was not not only used by UBS. According to the FT’s Lex, four-fifths of the US$16bn net profits  in the latest announced results of (BoA, Citi, JPMorgan, Morgan Stanley and Goldman Sachs came from using used the same accounting treatment of the banks’ own debts.

Lex describes the accounting treament thus: ” Try this on your credit card company: your creditworthiness has weakened, so you write down the value of what you owe them to reflect the greater riskthat you will not pay it back and credit the difference to your personal account. That is what exactly accounting allows”.

Minibonds Revisited

In Investment banking, Investments on 02/01/2010 at 5:44 am

I nearly bought minibonds in 2007, and since the failure of Lehman Brothers last year, I’ve been trying to understand why I nearly bought them. It is important to me as it could help me avoid a future disaster.

I always knew why I didn’t buy — greed. Dr Money sums this greed up nicely when he wrote, “Your money gets invested in risky bonds and derivatives. It means total returns are much higher, like 13 per cent or more. But all you see is your safe-looking 5 per cent return.

‘The difference of 13 – 5 = 8 per cent goes to the deal-maker while you must take all the risks. If the bonds default, you lose.”

Then there is the issue that if interest rates collapsed, the arranger could recall the note, while if inflation went to 10% (remember the price of oil then), I’d be stuck with 5%.

But I didn’t know why I nearly bought i.e. think it was a safe product, despite being “aware” of the risk premium. This is worrying. I could misanalyse again.

I’ve very recently come to the conclusion that my mind (without me being conscious of it — mindlessness in Zen) divided the risk element into two bits.

Risk 1

I “knew” (I was relying on the ads and a BT newspaper article) that

– I was (with many others) insuring someone against the failure of one of the six entities

– the product was highly leveraged

– derivatives were being used

– the combination of the last two meant that it was likely that if one entity got into trouble I would lose my money.

(Having read the prospectus last yr, the above points were confirmed.)

Risk 2

The probability of a default by Lehman or one of the entities.

My conscious mind came to the conclusion that the probability of default by Lehman or one of the six entities was very, very low (so far none of the six entities are in trouble). Dr Money had a great take on the improbability of an LB failure. I can do no better.

The very low probability of failure must have made me conclude that it was a safe product, and that LB had found investors who had mispriced risk — willing to pay the 13% mentioned by Dr Money. Not surprising as my experience as an arbitrageur (risk and straight) had taught me that risk is usually mispriced (investors are too cautious — Yes if I were still arbitraging, my employer would have lost big time in 2008 )

What has all this to do with forcing a settlement that Tan Kin Lian and others wanted? That the MAS refused to even think about.  It told them to bugger off.

Supposing there was no mis-selling: investors in minibonds and DBS HN5 notes were told everything and I mean everything. Would investors still have bought?

I think that most would have. Of course they would deny this today. “They would, wouldn’t they?”

They would have been advised, and rightly so (at the time), that the very low probability of failure, meant that their principal was safe.

The lessons of the story- better to be lucky than smart and going for yield is dangerous.

Good 2010 and decade.

Where value investing can go wrong

In GIC, Investment banking, Investments, Temasek on 24/11/2009 at 8:25 am

“A study by Standard & Poor’s, one of the world’s leading credit rating agencies, has raised questions over the financial strength of some of the biggest banks ahead of new rules that could require them to raise more funds.

‘The analysis by S&P showed that HSBC is the best capitalised bank in the world, while Switzerland’s UBS, Citigroup of the US and several of Japan’s biggest banks are among the weakest.”: an excerpt from the FT.

No the purpose is not to show that highly paid managers at GIC goffed, or how smart I am. I have been a shareholder of HSBC since the 1980s. Even during Green’s (Christian + McKinsey, a lethal combination that always leads to problems) tenure as CEO, I kept the faith.

Now that the CEO is a man who joined the bank as an International Officer from a minor public school with I think A-levels, and he is basing himself in HK, one can only expect the return to the values that made HSBC great during the tenures of Sandberg, Purvis and Bond. Oh Purvis won the Military Cross in Korea, when he disobeyed orders to withdraw. He claimed he couldn’t hear the radio messge.

Sorry I am digressing. When Temasek bought into Merrill Lynch and Barclays and  GIC into UBS and Citi, I realised that they were buying into highly efficient banking machines. There was just enough capital for regulatory reasons and to provide a buffer for some things going wrong.  They needed a bit more cushion and GIC, Temasek were providing it.  Risky but history was on their side.

When the world recovered from the credit crunch of 2006, 2007, GIC and Temasek would reap the rewards of these finely tuned cash machines. They were the equivalent of the best of the best F1 cars.  I thought we had smart boys and gals. And that the risk would pay off.

But then came Bear Sterns, Lehman Brothers and AIG, and the rules changed. The winners were the better capitalised banks. If HSBC had as little capital as Citi, I’d be a poor man. The amounts it had to write-off on US sub prime would have shmed Citi. But it had capital.

So value investing doesn’t always pay off.


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