Guest Post: Gossip From The Wall Street Journal's Future Of Finance Initiative

Tyler Durden's picture

Submitted by Janet Tavakoli, via Huffington Post

Last week I was a participant in the Wall Street Journal's Future of Finance Initiative in England. WSJ has written a summary of the conference highlights, and missed some key points. Allow me to fill in the blanks.

Paul Volcker, former Fed Chairman and current Chair of the President's Economic Advisory Board, made the most worthwhile comments.
Moral hazard was not discussed in the open forums, so Volcker reminded
the assembly. Yet even Volcker did not broach the topic of fraud.

Alistair Darling, Chancellor of the Exchequer, spoke on the opening evening. I asked him why massive financial fraud
remained unaddressed. Darling appeared momentarily confused and seemed
to suggest this was exclusively a U.S. problem to be handled by the
courts. I pushed back on this notion. By the time one needs a lawyer,
it is too late. I noted that we, the middle aged financiers in the
room, are responsible for taking action. If we don't face this issue
head on, we will never restore trust in the financial system.

Ana Botin, Banesto's Executive Chairman, suggested that the risk
manager should report to the board. Then she blew it with the
assertion--made several times--that the CEO can also be Chairman. (Ken
Lewis defended his dual role as CEO and Chairman of Bank of America at
a Fed conference in 2003. How did that work out?)

I didn't challenge Botin's assertion, because I used my two minutes
(literally) during the "Too Big to Fail" breakout session to
(unsuccessfully) try to carry the point that when banks fail, we should
allow shareholders to be wiped out, and debt holders should take
losses. (Under that scenario, most of the current managers would be
booted out.) Instead, the group posted the need for a "living will" to
be designed by the managers that made life support during our recent
crisis a debatable necessity.

Elizabeth Corley, CEO of Allianz Global Investors in Europe, presented conclusions from her panel's discussion of
the "Regulatory Frontier." The panel's idea of upgrading regulatory
resources was to deploy senior financial institution officers to
regulators for two or three years and vice versa. Meanwhile, the
financial institutions should chip in to maintain the regulators'
former high pay. Howard Davies of the London School of Economics saved
me from having to explain the concept of regulatory capture. After he
spoke, I was the only one to clap. Apparently everyone else thought the
panel was titled the "Predatory Frontier."

Robert Diamond, president of Barlcays PLC, sounded like a financial holocaust denier.
He seemed to think that the idea of breaking up banks has only to do
with the threat to the financial system, if they fail. The point is
that some of these institutions threatened the financial system--and
continue to threaten the financial system--because they are too big to

Diamond seemed to dislike the term "socially useless" to describe
recent financial innovation and defended Barclays' proprietary trading.
Since Barclays has dropped its suit involving its total return swap with
Bear Stearns' imploded hedge funds, Diamond may have already forgotten
this relevant example of financial innovation gone wrong. Hedge fund
investors were wiped out, the hedge funds' dodgy assets landed on Bear
Stearns's balance sheet, and later on JPMorgan Chase's balance sheet,
after it acquired Bear Stearns. Our past crisis taught us that hedge
funds are not independent of the banking system. This transaction
wasn't merely socially useless, it had negative social utility.

Mario Draghi, Bank of Italy's Governor and Chairman of the Financial
Stability Board, seemed to think that hedge funds are independent. This
is simply incorrect. If the example above didn't persuade him, he might
consider the assets that came back onto bank balance sheets and
contributed to market instability. For example, in March of 2008 as
Bear Stearns bit the dust, the Carlyle Group's CCC fund assets and the
assets of Peloton's funds boomeranged back on bank balance sheets at
the most inopportune time.

Bob Diamond defended structured credit products saying there is a
real purpose for structuring credit for pension funds. He was probably
unaware that state pension funds in the United States were damaged by
the unintended consequences of a "AAA" rated structured credit product.
The pension funds were wise enough to avoid investing in the product,
yet as I explained in my February 2007 letter to the Securities and Exchange Commission, large fixed income pension funds were unintenionally harmed by the market distortions caused by this financial innovation.

My letter to the SEC cited this financial innovation as an example
of why the special NRSRO designation of the rating agencies should be
revoked. The product did not deserve its "AAA" rating. It had
substantial principal risk and deserved a non-investment grade, or junk
rating. Within a year all of these new "AAA" innovations blew up.
Moody's estimated that investors in one of them would get back only
around ten cents on the dollar.

Not all financial innovation is harmful, but it is undeniable that
in recent years it was a runaway train that nearly derailed the global
financial system. You wouldn't have realized that, if you listened to
most of the participants. They chiefly represented the interests of
large financial institutions, and the financial system is still
attached to the privileged placenta of central banks doling out
taxpayer subsidies. Most of the conference reflected the insulated
thinking of this protective womb.

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AngryVoter's picture

The hope of an intellectual revolution seems less likely since the voices of reason like Janet appear to be ignored by the decision makers.

Anonymous's picture

It's not about reason. It's about insulated greed.

crzyhun's picture

Good God...these are the thought to be the sharpest pencil in the pack and we get this? Stunningly awful. We are more down the shoot than I imagined. JT helped clear it up some, however. Think and add W/DC to this mix and I get even more worried and horrified.

AngryVoter's picture

And just imagine the trouble we would be in if they weren't able to retain these the best and brightest.  Please, bunch of worthless snake oil salesmen.  We can only hope that at some point the public disgust reaches a level where they start removing deposits from C, JPM, BAC and WFC.  It wouldn't take long to shut them down if people stop doing business with them.

ShankyS's picture

Sadly that is what it will take, but at that point it will be to late (if not already). They will have the reinflation engine running at 1000% till it blows a gasket and when that happens, we are one step from total anarchy IMO. Would it be to much to ask for them to pay any attention to what the people want?


Anonymous's picture

Start removing deposits? I think we hit that point. I have been telling everyone I know to do just that for over a year.

Daedal's picture

it is undeniable that in recent years it was a runaway train that nearly derailed the global financial system. You wouldn't have realized that, if you listened to most of the participants. They chiefly represented the interests of large financial institutions, and the financial system is still attached to the privileged placenta of central banks doling out taxpayer subsidies. Most of the conference reflected the insulated thinking of this protective womb.



Rainman's picture

Never mention the word " FRAUD " in a room full of these clowns.

It would be more socially acceptable to cut a huge bacon grease fart.

naiverealist's picture

I can't say how much I really appreciate Janet's "out of the mainstream" identification of what is really happening to the financial world.  We see more and more that instead of the "best and the brightest", these financial "giants" see themselves as the uber-protected elite that deserve the money and status they get just because of who they are (i. e. the definition of "royalty"?). 

Just because we know, what can we do about it?

jm's picture

Of course eliminate the CEO/chairman of the board incest.

With all due respect, I don't think Janet goes deep enough.  I believe the risk management officer should not be answerable to the CEO.  He should be directly answerable to the board chairman.  This will create the independence needed to present the real risks inherent in the organization, and will not put sand in the wheels of positive innovation.

This risk manager should be compentent to calculate CVaR and shortfall using a number of different distributional assumptions, like normality, Pearson t or type IV, or Weibull; he should be financially experienced enough to have a real "feel for the cloth"; he also needs a respect for history, and the ability to communicate maths in an understandable way to the board.

A lot of times, risk management as it stands right now is just technical masturbation used as a justification for crazy-ass behavior. 


Anonymous's picture

Agreed on Risk independence. Several articles in the past from insiders being pressured to rate deals better than warranted. Not healthy.

Kudos to Janet for an informative post.

Anonymous's picture

Thank you, Janet. You're doing great work.

Is the word "Gossip" (in this article's title) Janet's choice or ZH's? It seems pejorative.

chet's picture

I love the suggestion of "improving" regulatory enforcement by swapping employees between the banks and the regulators.

I don't know whether to keel over laughing, or go down to the my Y2K bunker and shrivel into the fetal position, thinking about how fucked we are that the banks have learned nothing at all.

bokapita's picture

Most interesting and illuminating piece. I have a friend whose analysis of all of this is at the political level, and he considers that a transnational elite has captured the levers of power and that this elite operates above the national level of loyalty; rather it is loyal to its own transnational class interests. I never completely bought into this idea until reading this piece.

Allister Darling probably did not follow the point about fraud, by the by, as this has been carefully filtered out of the UK MSM, and for sure he is NOT the SPITB. And God forbid that a treasury mandarin should suggest such a thing as FRAUD as a possibility to his or her political master.

The internal belief system within the banking/treasury bubble is entirely self-referential and never hears what it does not wish to hear. Just one example, the UK government has been buying its infrastructure for the last 10 years 'on the drip'. That is, by paying for it on hire purchase via private sector financing, rather than through taxation or direct government borrowing, solely in order to fudge a statistic called the Public Sector Borrowing Requirement. Thereby 'proving' that government borrowing was not more than "X" percent GDP! All and sundry bought into this complete legerdemain.

So no surprises that the conference attendees were unprepared for a shot of reality. What I WAS surprised by in this piece was that these clowns did not even have the sense to parade out a few (meaningless) mea culpas in order to defuse the only too true accusations.

My only caveat is that stupidity can never be ruled out. I for one find no evidence whatsoever that these people are individually or collectively a set of sharp pencils. Rather, they are probably just rather ignorant of the real economy that their silly fraudulent, destructive businesses' are standing upon. They will, of course, find out the hard way; but so, of course, will all the hard working, sensible, honest people who built and work in the real economy.

This whole guastly mess, throughout the West, is the finest evidence possible that we all have either (a) dishonest leadership groups or (b) stupid ones. The question for the future is, how do we fix the problem?

kennard's picture

Buyer beware should be always the starting point. Financial regulation impedes market forces and provides AAA cover for the real theft.

Anonymous's picture

kennard you are so correct.

quote from a senior FSA (UK financial regulator) officer

" misunderstand the goal of the FSA [laughing], it is to ensure the profits and competitive position of the big established players and increase entry costs to competitors...."

Anonymous's picture

Many years ago (mid 80's) while designing software to run companies (OE,Scheduling,Pricing,Shipping,Billing, etc)there were many standard accounting practices that were built into each module that overall prevented "fox in henhouse" practices. For ex, Order managers could not override prices while entering orders without due process and approvals. As the years passed there came a steady deterioration in upholding proper division of duties and more and more it became the fox guarding the henhouse. Eventually it was the fox's henhouse completely.
I have witnessed the same breakdown throughout most industries and organizations within our society.
In fact it has become so ubiquitous that my childrens' generation (genx) and the current generation don't even recognize conflict of interests. Corruption is systemic.

Anonymous's picture

To some extent, what you describe is also the result
of extensive down-sizing. As fewer people do the jobs
of the many laid off, more authority falls into fewer
hands as a by-product. So audit control disappears.

Anonymous's picture

That's the last time Janet gets an invite....

Terminal Frost's picture

The only thing more disheartening than the budget deficit is the leadership deficit.  The real leaders with real ideas are marginalized on their best days and completely ignored on their worst.

JohnKing's picture

Janet has it going on. Fraud is the root of the problem and until the axe lays it bare we don't stand a chance.

Anonymous's picture

If "social utility" (liberal central planner term) is the requirement for products, then we are going to need to talk about lots of companies and lots of products. I would love to see the definition of "social utility."