Wednesday, October 12, 2011

WSJ's Francesco Guerrera says 'banking chiefs must come clean about risk'

In his Wall Street Journal column, Francesco Guerrera calls for banking chiefs to come clean about the risks that their firms are exposed to.

It is one thing for your humble blogger to say that investors want granular level data.

It is another when the WSJ's Mr. Guerrera confirms it.  He lays out in no uncertain fashion that investors want and are now demanding that the global financial institutions provide all the facts and not just verbal assurances about the risks these firms are exposed to.
With microphones ready, analysts' spreadsheets wide open and journalists' fingers poised over keyboards, the likes of J.P. Morgan's James Dimon,Goldman Sachs Group Inc.'s Lloyd Blankfein and Morgan Stanley's James Gorman will have to persuade us that—yes, you guessed it—this time is different from 2008. 
But here is the rub: Simply saying it, which seems to be the Wall Street titans' preferred way of dealing with the issue so far, won't do the trick. Investors are in doubting-Thomas mode and need facts and figures. 
You can't blame the market for demanding proof of banks' health .... The reasons are known: a double-whammy of sovereign/banking turmoil in Europe and an anemic U.S. economy. 
Yet, the response to investors' fears from Wall Street's corner offices has been underwhelming, especially on Europe.
The arguments used by financial chiefs can be summarized thus: "Nothing to see here," and "Trust me, I am a Wall Street chief executive."  
Unsurprising, neither has reassured investors. 
Take the first line of defense. Wall Street firms have rebuffed investors' questions about their exposure to Europe's troubled GIIPS (Greece, Ireland, Italy, Portugal and Spain) with words like "nominal," "manageable" or "well-hedged." 
Such arguments are disingenuous, at best, because they refer to "net" exposures—the difference between gains and losses once all derivative trades are completed. 
Unfortunately, net exposures are theoretical concepts, a bit like Platonic ideals of a balance sheet, based on the assumption that in a crisis all the derivatives contracts U.S. banks have with counterparties will be honored at the same time. 
That is one big assumption. "Using net exposure assumes high quality of collateral and that hedges work in 'tail scenarios,' neither of which are certain," wrote Richard Ramsden, a Goldman Sachs analyst, in a note to clients last week. 
In fact, when Lehman Brothers Holdings collapsed in 2008, it was a breakdown in the derivatives markets that exacerbated the aftershocks of the bankruptcy. 
Mr. Ramsden estimates that large U.S. banks could be on the hook for $641 billion in GIIPS countries, if all derivatives, guarantees and commitments were taken into account. That is a lot more than the $150 billion or so of exposure Wall Street likes to talk about. 
That difference of, give or take, half a trillion dollars is the stuff of nightmares for investors. 
Unless, that is, banks bridge the gap between fact and fear with a granular account of what is in those derivatives books, how much could really go wrong should Greece and other countries default and how good the collateral and hedges are. 
Please re-read how the way to bridge the gap between fear and confidence is to provide granular level data.  This is a point your humble blogger has made repeatedly.
When I asked executives from several banks why they haven't been more forthcoming, they mentioned the inherent complexity of their derivatives trades and concerns that rivals might steal their secrets—two reasons that might be valid in normal circumstances but that pale into insignificance in the current environment.
Complexity is a form of opacity and opacity is not valid under any circumstances. Wall Street uses opacity as the vehicle for privatizing the gains and socializing the losses of its trades.  It is this opacity into the derivatives book that investors are concerned about.

As for the idea that rivals might steal their secrets, aren't Wall Street firms suppose to be out of the proprietary trading business.  Disclosing the granular level data for a derivatives book should be a non-issue when a firm is just a market maker.
 Heightened disclosure has often been used by banks to soothe investors' nerves. During the last crisis, financial groups produced warts-and-all accounts of their mortgage-backed securities as investors clamored to understand how toxic their balance sheets had become.
This blog has documented this heightened disclosure in Europe by Societe Generale and BNP Paribas including the call by one of their chief executives for 'utter transparency'.
My sources say that some firms will provide more details about European exposures with their results. While they are at it, they should also swamp investors with details of their funding situations, reliance on "hot money" from hedge funds and equity- and debt-raising plans (and perhaps explain why now it is a good idea to use their money to buy back shares). 
There is no amount of detail that the firms could provide that would swamp the market participants.  Remember, included in the firms doing the analysis on the disclosed data are the Wall Street firms themselves.
The problem faced by Wall Street chiefs is that, after the turbulent events of three years ago, they can't really ask the financial community to leave them alone and let them deal with the situation. The trust train left the station in September 2008 and isn't coming back anytime soon. 
After being less than open on anything from collaterized debt obligations to off-balance sheet "SIVs" and auction-rate securities, U.S. banks can't expect investors to take their latest reassurances at face value. 
"The best surprise is no surprise," says Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "It is not as if investors have a ton of confidence in management and revealing it all could lead to them losing faith in management: They have already lost faith." 
It is time for bank chiefs to lift the veil on their finances. Unless Wall Street does the talking, investors' mounting fears will take over the conversation.
Since all of the Wall Street firms know how to reach me, your humble blogger looks forward to the bank chiefs listening to the investors and contacting me.  The conversation will focus on putting together a data warehouse with all of their granular data that is available to all market participants.

1 comment:

Joe Rebholz said...

Really. I thought everybody had perfect information already.