A value-at-risk model basically works like this. You have some stuff, which is worth X today. Tomorrow it will be worth X + Y, where Y ranges from more or less negative infinity to positive infinity. Y is a function of a bunch of correlated random variables, rates and credit and stock prices and general whatnot. You look at a distribution of moves in those variables and take (usually) a 2-standard deviation daily move; if 95% of the time rates move by -10 to +10 basis points, your VaR model will assume a -10bp or +10bp move, whichever is bad for you. You take the 95%-worst-case, taking into account correlation etc., and tot up how much you’d lose in that case. Then you write that number down and feel a bit better, since you’ve sort of implicitly replaced “we have $X today and will have some number between negative and positive infinity tomorrow” with “we have $X today and will have some number between ($X – VaR) and positive infinity tomorrow,” though of course the first statement is true but unhelpful and the second is not true and also unhelpful.
But that aside! You get your VaR from a distribution of your variables, but the obvious question is what distribution. A good answer would be like “the distribution of those variables over the next three months,” say, for quarterly reporting, but of course that is only a good answer because it begs the question; if you knew what would happen over the next three months you would, one assume, always end those three months with more than $X and this VaR thing would be moot or moot-ish.1
So instead you look at things that you think will allow you to predict that future distribution as accurately as possible, which is epistemically troubling since VaR is a measure of how inaccurate your predictions might turn out to be. Anyway! You pick a distribution of variables based on the sort of stuff that you always use to estimate future distributions in your future-distribution-estimating business, which could mean distributions implied by market prices (e.g. option implied vol) but which seems to mostly mean historical distributions. You look at the last N days of data and assume that the world will be similarly distributed in the following M days, because really what else is there to do.
Picking the number of days to use is hard because, one, this is in some strict sense a nonsense endeavor, but also two, the world changes over time, so looking back one year is for instance rather different from looking back four years. Here is how different: Read more »
There’s a thing called “corporate governance” which you might think means like “the practice of running a corporation in a good way instead of a bad way” but you would be wrong. You can tell because the consensus is that Citi has displayed good corporate governance by making a chaotic demoralizing mess of firing Vikram Pandit in disgrace and/or regretfully accepting his voluntary resignation and/or other. Here’s Felix Salmon:
The CEO’s job is to run the bank, to answer to the board, and to get fired if he doesn’t perform. Which is what seems to have happened with Pandit.
Meanwhile, further downtown, the exact opposite is happening. Where Citi’s powerful board acted decisively after yet another set of weak results, Goldman’s powerless board is simply sitting back and watching their bank report a much more solid set of earnings …
[W]hile investors care about earnings first and foremost, they also want to know that they’ll ultimately receive those earnings, rather than just seeing them disappear into the pockets of management, or be wasted on silly acquisitions. Governance matters. And on that front, if on few others, Citi can credibly claim to be leagues ahead of Goldman.
I say unto you that one or the other of these statements can be true, but not both:
- “Governance matters.”
- “on that front, if on few others, Citi can credibly claim to be leagues ahead of Goldman.”
Read more »
I don’t have much insight into Citi’s earnings but I do enjoy the reporting of them. When a car or Facebook company reports earnings you basically ask questions like “how many cars or Facebooks did it sell?” and “how much money did it make on each one?” and those questions are kind of answerable and their answers give you a sense of how you should feel in your heart about the company. When a bank – like, a bank bank – reports earnings you can ask “how many mortgages did it sell?” and “how much money did it make on each one?” and those answers will be useful to you too, though there will be murky liquidity and valuation overhangs that will reduce their usefulness.
If you asked those questions of Citi, you might or might not get answers that might or might not be useful, but you’d be hard pressed to translate them into the headlines on Citi’s earnings. Big banks are not primarily engines for selling products and collecting a margin on them; they are bundles of accounting decisions, and this is never more apparent than at earnings time. This is pretty far removed from economic activity in the world:
Citigroup Inc.’s third-quarter profit fell 88% as the bank took charges tied to the value of its debt and the sale of a stake in its brokerage joint venture …
Others chose to emphasize economic activity in the world, at the cost of, y’know, GAAP: Read more »
JPMorgan did its third-quarter earnings call this morning, and even though the London Whale was a pretty minor presence on the call I was still going to throw up a picture of a whale here because (1) why stoke Jamie’s ego further and (2) who doesn’t like whales, but then the operator asked for closing remarks, and Jamie Dimon closed the call by saying “I’m just surprised no one mentioned how handsome Doug Braunstein looked in that article in the Wall Street Journal,”1 and, well, that happened, and we’re each going to have to deal with it in our own way, but in any case, Doug Braunstein, ladies and gentlemen.
I HAVE NOT FORSAKEN YOU WHALEDEMORT and we’ll talk about him in a bit when I can get my emotions in check but for now I guess we owe it to that handsome cherub to your left to talk about JPMorgan’s business a bit so let’s do that.
JPMorgan’s business: It is good! Records were set, expectations exceeded, the stock … um, opened down, but got better. (Then got worse again! I don’t know.) The other day I suggested that underwriting 30-year investment-grade bonds is sort of a bad business because you make 87.5bps now, but then your client is all set for 30 years, so it’s really only 3bps a year, which is not much compared to basically any other method of providing money to companies, except ironically actually lending them money (if they are high investment grade), which is just a pure loser. I more or less stand by that in a big-picture sense, but of course 30 years is well into IBGYBG territory and it feels great to make 87.5bps now, so now you’re happy. JPMorgan is I guess underwriting a lot of 30-year bonds; more to the point it’s underwriting a lot of 30-year mortgages.
A toy model you could have of the mortgage market is: Read more »
Ooh so Wells Fargo screwed the government out of hundreds of millions of dollars of mortgage insurance by fraudulent underwriting, allegedly. We’ve all heard big-bank mortgage fraud stories by now and they’re usually pretty juicy and smoking-gun-tastic: “shit breathers,” etc. And the government claims that WFC submitted somewhere between 6,000 and 50,000 bad loans, while specifically describing a dozen or so in the complaint, presumably cherry-picked for maximum offensiveness. Let’s look at one:
92. FHA case number 352-4948464 relates to a property on Martin Luther King Blvd. in Newark, NJ (the “King Blvd. Property”). Wells Fargo underwrote the mortgage for the King Blvd. Property, reviewed and approved it for FHA insurance, and certified that a DE underwriter had conducted the required due diligence on the loan application and that the loan was eligible for HUD mortgage insurance. The mortgage closed on or about July 23, 2003.
93. Contrary to Wells Fargo’s certification, Wells Fargo did not comply with HUD rules in reviewing and approving this loan for FHA insurance, and did not exercise due diligence in underwriting the mortgage. Instead, Wells Fargo violated multiple HUD rules, including HUD Handbook 4155.1 ¶¶ 2-3 and 3-1, HUD Handbook 4000.4 ¶ 2-4(c)(5), and Mortgagee Letters 1992-5 and 2001-01.
94. Wells Fargo’s violation of HUD Handbook 4155.1 ¶ 2-3 is illustrative of the multiple rules that Wells Fargo violated in approving the King Blvd. Property. HUD underwriting guidelines state that lenders must analyze a mortgage applicant’s credit and determine the creditworthiness of the applicant. Specifically, lenders must verify and analyze the borrower’s payment history of housing obligations, and obtain written explanations from the borrower of past derogatory credit. HUD Handbook 4155.1 ¶ 2-3. Contrary to this clear requirement, Wells Fargo failed to verify the borrower’s history of housing obligations or obtain explanations from the borrower for past derogatory credit. In violating HUD Handbook 4155.1 ¶ 2-3, Wells Fargo endorsed the King Blvd. Property for FHA insurance without sufficiently analyzing the borrower’s creditworthiness.
Gosh! Failure to verify history of housing obligations! Unobtained explanations for past derogatory credit! INSUFFICIENT ANALYSIS!
What? Read more »
There’s a lot of The Future Of Banking in the news today and we should talk about it but first a proposition. Where are you more likely to lose money on a mark-to-market basis: buying 5-year PIK-toggle holdco Petco bonds at 8.6%, or buying 30-year UPS bonds at 3.625%? I say your odds of losing on UPS are higher; if you disagree, you take Petco, and we’ll meet here in 30 years to settle up.
Here is a grab-bag of other numbers related to UPS:
Things to think here include:
- lending money to UPS is not profitable for banks2;
- underwriting UPS’s 30-year bonds isn’t exactly a bonanza either; and
- UPS would be nuts to borrow from its banks – so it doesn’t, and borrows more cheaply in the market.3
Bank lending to high-investment-grade companies is (1) a loss leader, (2) used to attract not especially profitable business, and (3) not competitively priced. I feel like other industries do loss leaders better.
While you ponder that, also ponder this IMF working paper on banks and trading. A quick takeaway is “banks shouldn’t trade, urgh, trading bad,” and Mark Gongloff and Felix Salmon take that takeaway away, but as far as I can tell the more interesting bit is this: Read more »
In the war against bankers’ pay the EU has a secret weapon:
Banks should pay bonuses in debt, which would be wiped out if a bank failed, an EU banking report will suggest as Europe attempts to step up the fight against bankers’ pay.
I’ve been sort of fond of this for a while. It’s a way for bankers to eat their own cooking: if you’re a banker, what you produce, more or less, is debt, so you might as well stand behind the basic soundness of that debt by owning lots of it. You can fine-tune this theory – for instance, Credit Suisse circa 2008 produced asset-backed securities, and Credit Suisse circa 2011 produced derivatives-counterparty credit risk, so that’s what its bankers got – but the basics are sound. In particular, if you are a banker, one thing that you don’t produce – that is sort of an unwanted byproduct of your operations, imposed by regulators but not particularly liked by you – is equity, so getting paid in equity is a little perverse.1
There’s a little theoretical tension here, though, which is that there’s also good reason to think that bankers should be the lowest on the totem pole in terms of getting their money back if they blow up their banks. You could just about imagine a bank capitalized with 10% equity, 10% banker-pay junior debt, and 80% senior debt, say, failing and recovering 85 cents on the dollar. So the real debt gets paid off 100%, but where does the 5 cents go? Classically the “debt” that the bankers get is senior to the “equity” that public shareholders get, but it seems a bit rough to pay the nasty bankers before you pay the widow-and-orphan shareholders. Read more »
Buried in a footnote1 a while back I ruminated on the fact that, in the deal where Morgan Stanley bought a chunk of its Morgan Stanley Smith Barney brokerage JV from Citigroup, Morgan Stanley got a sort-of-free option to buy the rest of Smith Barney, and how that option is (1) valuable and (2) sort of cheap funding. That was basically all wrong, sorry! The lesson is, never read footnotes.
Charlie Gasparino is reporting that “Morgan Stanley chief James Gorman is making a full-court press with regulators to expedite the purchase of the remaining piece of the Smith Barney brokerage firm from Citigroup, moving up the buyout date as much as two years ahead of schedule,” so I guess Gorman puts the time value of that option at zero or less. As for cheap funding, Goldman had a research note this week saying that they met with Morgan Stanley and heard the same story, and also that:
At the margin, full MSSB ownership should have a meaningful impact on ROE as: 1) MS is still paying Citigroup a portion of earnings from the JV despite holding capital to support the entire business, 2) synergies with the Institutional Securities business will grow (i.e. client flow routing), and 3) the funding profile and client product offering mix will improve.
I think the second two things say something like “Citi won’t appreciate us shoving all of our MSSB customers into high-margin Morgan Stanley products, so we have to get rid of them before doing that,” though you could read them otherwise. The first thing calls the cheap-funding argument into some doubt, though maybe not that much doubt; Morgan Stanley’s capital is by some metrics cheaper than Citi’s, while its (credit market) funding is more expensive, so maybe this is still a good deal.
Anyway here’s what Gasparino has to say about the delay: Read more »
Here’s an interesting set of slides that Morgan Stanley CFO Ruth Porat presented at the Barclays conference today. For some reason this one struck me:
Morgan Stanley: basically a mutual fund! Half a mutual fund. Really barely at all an investment bank, which I guess is the way of the world for investment banks, but still sort of stark to see it there in black and white, er, navy and yellow. And Morgan Stanley will be shifting even more toward wealth/asset managing after today’s hotly negotiated purchase of Morgan Stanley Smith Barney.1 As Reuters puts it: Read more »
Wall Street banks’ research on their competitors is not only a window into analysts’ anxieties about their own banks’ prospects, but also a ripe area for conflicts between investment advice and industry advocacy. The days of analysts writing research reports that were like “Facebook should really do a huge equity offering and hire my bank as sole underwriter,” or whatever, are mostly behind us, but when banks write about their industry you might wonder if they’re giving dispassionate advice or pushing their employer’s interests. And when they write about their competitors it must be tempting to be a bit underminey. So various banks have published research saying “actually breaking up the big banks would be bad for shareholders,” which may be true but also not un-self-interested, as breaking up the big banks would surely be bad for the equity research analysts they employ. And then Morgan Stanley published a don’t-break-up-the-banks piece saying “… except Citi,”1 and if you knew that MS is in the process of trying to buy a chunk of Citi cheaply you might be like hmmm. Today Goldman recommends that Morgan Stanley get out of fixed-income trading, and, again: suspicious!
That’s arguably not their main point; much like JPMorgan last week, GS set out to quantify how much of their fun financial regulation is ruining, which again you could read as advocacy. Even though it’s the opposite of what Lloyd is advocating. Here’s Bloomberg:
New bank regulations and capital requirements are “structural” changes to the industry that are more to blame for declining profits than the U.S. economic slump, Goldman Sachs Group Inc. analysts said.
“The operating environment is unlikely to change any time soon, and we see shareholders of challenged banks becoming more demanding in asking management teams to lay out a path to unlocking value in the near term,” analysts led by Richard Ramsden in New York wrote in a report published today.
Their view contrasts with Goldman Sachs Chief Executive Officer Lloyd C. Blankfein, who said in November, “I don’t think we can conclude that the slowdown is secular rather than cyclical change.”
Here is their main chart, which is sad though perhaps too soon to call secular: Read more »
I like reading banks’ research reports on other banks these days because they give off a certain the-call-is-coming-from-inside-the-house vibe; you imagine the analyst running the numbers, looking them over, and saying “my God, this can’t be right, can it? This seems to say … I’m fired?” JPMorgan’s analysts maybe suffer from this less than most but it still imparts a certain tension to the marvelous, strange, 100-page research note out of J.P. Morgan Cazenove today about global investment banks.* There are two big important points** which are:
(1) European banks are pretty pretty aggressive with how they risk-weight their risk-weighted assets, especially compared to US banks. Basel’s Standards Implementation Group is moving in the direction of requiring convergence on RWA measurement, and JPM thinks that that will lead to the European banks having to revise their RWA measurements – meaning that those banks’ capital positions will look much worse than they do now and they will need to shed RWAs and/or raise capital.
(2) You can quantify the return-on-equity effects of new banking regulation – including Basel RWA convergence, but also things like derivatives clearing, the Volcker Rule, etc. – on the big global banks, and those effects are bad. Bad for shareholders, anyway: per JPMorgan, global-bank average ROE would be 16% in 2013 but for those regulations, while after giving effect to them it will be just 6.3%.
But I presume that like any good utility maximizer you care only about your comp, so the important takesaways are (1) 6.3% is not good enough and (2) it will be remediated out of your pocket. Which leads JPMorgan into the truly chilling: Read more »