

Shadow Banking: Goldman’s derivative exposure 25K% of assets in ‘08, 33K% in ‘09 - dsplittgerber
http://www.levy.org/pubs/wp_587.pdf

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T_S_
OK. This statistic refers to notional value. Adding up notional values makes
as much sense as adding apples, oranges, yen and dollars. Actually it makes
less sense than that. You cannot understand a bank's book without access to
the individual line items.

If you have the line items, you have everything. Without that you have to rely
on high level financial statements and the opinions of bank examiners or other
regulators. And as Lehman, Madoff, Enron and other cases show, it means you
have nothing.

It is time for banks, who operate a public trust, to offer continuous (lagged)
line item disclosure to enable crowdsourcing of risk analysis. The markets are
running on the informational equivalent of fumes. No wonder they sputter.

I call this Real Transparency. It is no more intrusive than the fact that I
can find out how much you paid for your house and how much you borrowed to buy
it. Information like this is necessary for the functioning of a proper market
and price system. These are worth preserving more than the privileges of
banks.

Real Transparency is the kind of regulatory reform that would make a
difference. Not the kind which gives power hungry regulators more information
to ignore.

~~~
eru
> It is time for banks, who operate a public trust, to offer continuous
> (lagged) line item disclosure to enable crowdsourcing of risk analysis.

I read (probably in the Economist) that a regime like this is already in
operation in New Zealand or Australia (if memory serves me right).

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T_S_
I believe that you are referring to monetary policy in NZ. This is not the
same thing. Essentially I am suggesting that banks have about the same amount
of financial privacy that you and I do. They do a lot more transactions, so
there is much more for them to tell.

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grandalf
the derivative exposure could be risk-reducing, fwiw.

~~~
eru
It could. Though the netting out only works when your counter-parties turn up
to play their part.

~~~
grandalf
True... However it seems to me that singling out a specific type of
transaction (such as derivatives) because it faces this kind of risk (the risk
of the instrument * the risk of the counter-party) is a bit silly.

Much of what we finance is based on a mental model the future that might not
be true. Consider a mortgage. If your house burns down then you still owe the
payment.

So the financial industry invented "fire insurance" for the counter-party risk
of derivatives, called CDOs. But they too are blamed for the crisis.

The fact is, any set of financial products/buyers/sellers will converge upon a
non-worst-case view of the future, and the price of risk will adjust
accordingly. Any line you draw in the sand (such as for capital adequacy
requirements) is simply an estimate about how risky the future is... and
notably it's still a gamble that the future will occur at or above some point
in a probability distribution.

~~~
eru
I agree. Just for the record: I also love short-sellers.

~~~
T_S_
Short sellers got rough treatment during the crisis, much of it undeserved.
But we should not lump all short sellers together.

Fear mongers do exist, but they only thrive in a low information environment,
such as a panic. If banks and other companies provided, or were compelled to
provide better ongoing information, they wouldn't be exposed to rumors in the
first place. They probably wouldn't see their stocks overinflated either, due
to the actions of legitimate short sellers.

~~~
grandalf
I would argue that the "parasitic" short sellers who are information poor
should not be viewed differently than "long sellers" who are information
poor... and are generally considered perfectly acceptable.

A "panic" is just the price decreasing version of a bubble...

~~~
T_S_
I agree. Ever notice how the media always treat a stock market rally like a
sunny day? Too many sunny days bring a drought, which in this case means no
chance to buy value at a good price. Short sellers are like rain.

My main complaint is that investors are information-starved and our public
policy is to blame. All this outrage about people gaming the system is a
distraction. We need to fix the system, starting with the banks.

~~~
grandalf
I'm curious what your proposed solutions would be... mine are:

\- remove capital adequacy requirements as they (like a paper seatbelt) create
a false sense of security. Firms should compete on the basis of soundness as
well as other characteristics.

\- pass a law outlawing bank bailouts.

\- remove restrictions on non-accredited investors, short-selling,
derivatives/options trading.

\- Increase disclosure requirements for financial institutions.

\- Create a new financial statement called "Statement of Risk Exposure" which
is a list of the firms' assets in terms of risk. If an asset is on a debt owed
by another firm, then that firm's risk statement could be copied and inserted
inline, recursively.

~~~
T_S_
You can see my suggestions about transparency above. I won't repeat them here.
It provides the teeth to your disclosure requirement. I would suggest that
instead of asking for line items by risk, we simply open the banks' books and
get an electronic term sheet for everything listed. I don't want to know their
risk numbers. They calculated them.

Your other measures are interesting. I would keep capital adequacy but seize
the bank before capital went to zero. That would improve incentives a bit.

The key thing is to claw back the economic rents that bankers have been
handed. Most of these rents are connected to information that bankers have and
we don't. This can be changed, but not with the help of today's regulators who
are still in thrall to the banking industry despite their statements to the
contrary.

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mattmaroon
People (not economists) always blame the crisis on bad lending. That's like
saying the guy who had full-blown AIDS died of pneumonia. It's true in a
literal sense, but it's not meaningful in that you're blaming the symptom
rather than the disease.

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shrikant
Uh, it's 25 and 32 THOUSAND % each!

~~~
dsplittgerber
Had to shorten the title and missed inserting the K back in. My bad, sorry.

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mos1
Summing notional values is not an intelligent or accurate way to determine a
firm's derivative exposure.

Please don't use the terms interchangeably.

