My Childish Pleasure: Milestones, Satan and big(ish) numbers!

Woe to you Oh Earth and Sea
for the Devil sends the beast with wrath
because he knows the time is short

Let him who have understanding

reckon the number of the beast

for it is a human number
its number is six hundred and sixty six.

A pretty pathetic reader count...but it still made my day!

Raining Blood - Greece, Mercs, Merkel and the EFSF

Raining blood

From a lacerated sky

Bleeding its horror

Feeding my structure

Now I shall reign in blood!

- Raining Blood by Slayer - 

"One more referendum and I will fuck him up."

Today something vaguely frightening/flattering happened: the inimitable, esteemed and often unflappable blogger and keen observer to the human condition RogerofSicily dared me to explain or - even worse - make sense of the Kabuki theater that is the European effort to bail out Greece. It’s not exactly like he’s asking me to unify quantum physics and Einstein’s view of the world but it still made me kind of gulp with trepidation. But then again, this is Rock’n’RollFinance! So there, here we go: Challenge accepted! ...Don’t blame me if this gets boring half way through!

Rather than go straight to the “why bother?” part of the bail-out question, it might be worthwhile to start with the “how did we end up in this mess?” end. To brighten things up I’ll be channeling a bit of Teutonic working class heroism in an effort to bring us closer to comprehension. I’ll be drawing heavily on the efforts of Superfritz. Hope you don’t mind, but do consider yourself referenced!

So let’s step away from the global super-macro perspective and have a look at the German micro perspective to understand why this is (politically) not exactly straightforward. The story goes as follows:

German worker goes to work and builds a great Mercedes.

German worker gets paid 2,500 Euros, pays 1,000 Euros taxes/social security and saves 250 Euros on his savings account at stupid German bank, because he wants to buy a great Mercedes sometime in the future.

Stupid German bank takes the 250 Euros and buys some funny paper from a stupid US bank for 100 Euros and some more funny papers from US government for 100 Euros, converted into 100 Dollars. For good measure it also buys some 50 Euros of funny paper from the Greek government.

The stupid US bank is happy. It found someone even more stupid to buy its mortgage risks.

US government is happy. It has a handful of wars to run and taxes to break. Wars and tax breaks are expensive.

Greek government is happy. It has a legion of civil service unions to buy off and needs to keep up with the neighbours in the “buying-Bundeswehr-surplus-tanks” competition. Doesn’t have to bother with tax collection either now!

Stupid US bank pays huge bonus to banker who sold funny paper. Stupid German bank pays huge bonus to banker who bought funny paper.

Stupid US bank takes the 100 Euros and grants another mortgage to US IT consultant.

US IT consultant takes out mortgage, uses the money (incl. the 100 Euros saved by the German worker) to buy himself a great Mercedes for 100,000 Euros. Why wait and save to buy it? That's so 1950s! US IT consultant is happy. His house has turned him into millionaire. He drives a great Mercedes.

Mercedes is happy. It now has money to pay 2,500 Euro to the German worker, 10,000 to the German government and 87,500 Euros to its shareholders in Kuwait.

Kuwait shareholders are happy.

German government takes 10,000 Euros, pays 5,000 to pensioners and unemployed, 1,000 to Eastern Germany, 3,000 for "other expenses" and 1,000 Euros for non-existent olive trees in Greece and great Spanish Autobahns.

Greek farmer is happy. Considers buying a Mercedes. Spanish construction worker is happy. Considers buying a Mercedes. German worker doesn't really understand what's going on. Goes to work to build Mercedes.

Scene at the Eurozone bail-out summit

Restart at top. Repeat 10 times. 

= Trade imbalance.

Turns out, US IT consultants house is worth half his mortgage. US IT consultant gives house and car keys back to bank. Pity. But what a great time he had with his great Mercedes!

Stupid US bank goes bankrupt.

Stupid German bank reads the funny paper it bought from stupid US bank for the first time (500 pages in English, hello?) and finds out it's bankrupt, too.

German government uses taxes of German worker to bail out stupid German bank's shareholders. German worker's kids Kindergarten is not refurbished. No money left. But German worker still has savings of 250 Euros at state owned stupid German bank. Phew!

Stupid US bank is bailed out by US state, using the 100 Euros saved by German worker given to it by stupid German bank.

US government is broke. Invents new term for inflating debt away. "Quantitative easing”, sounds funny. German worker doesn't get it. 

US government returns 100 USD to stupid German bank. Bank converts 100 USD into 10 EUR. Ooops, 90 Euros gone. Stupid German bank is bankrupt again.

German government uses German workers taxes to bail out stupid German bank again. German worker's street is not repaired. No money left. But German worker still has savings of 250 Euros at state owned stupid German bank. Phew!

German bank now no longer keen on buying funny Greek government paper. Stops that non-sense. 

Greek government figures out it is broke too. Didn’t bother with tax collection. Why bother when stupid German bank gives you money? 

Enter ECB.

ECB council decides that sticking to rules is for stupid Germans. Easier without rules. Much more fun. Cranky Germans don't get the joke. Typical. ECB buys lots of Italian and Greek debt at knock-down price.

THE FUTURE:

ECB decides that 2% inflation is too ambitious. The rules are only paper, after all. ECB decides 10% inflation is better for majority of countries in ECB council. Cranky German still doesn't get the joke. Ah, these Germans...

German worker goes to bank. Wants to buy Mercedes with money saved. Bank gives him 250 EUR back. Plus interest. German worker is happy.

German worker goes to buy Mercedes. Turns out, Mercedes now costs 123,890,571,238,457 Euros, instead of 100,000 Euros. German worker uses savings to buy himself a glass of Schnaps instead. German worker is a bit cranky. Now understands what "Quantitative Easing" means. Doesn't get the joke. Lack of humour, presumably.

US banker: got huge bonus
German banker: got huge bonus
US IT Consultant: got Mercedes and huge house (for a while)
Mercedes shareholder: got dividend
Greek farmer: got subsidies
Spanish construction worker: got subsidies
Bond holders: got bailed out.
German worker: got bill.

German worker feels so 1950s. Needs to catch up with rest of world. Should have borrowed money years ago to buy Mercedes. Honest work and sticking to rules makes no sense. Quantitative Easing makes alles kaputt. 

Greek and British papers tell German workers it's all his fault because his granddad invaded Poland.

Merkel after the post summit press-conference

Not sure this explains what's going on but then again I'm not sure any of this _really_ makes sense.

I'm not even going to try explain how the EFSF is supposed to work in all this. I'll need to drink a lot more to try that. 

1%ers - Public Enemy Number One! Or maybe just your doctor.

1%ers - Strangely not including dope smoking bikers

I'm rather brazenly stealing somebody else's research for this (we call it "leveraging" work), but it's just too succinct for me to not put it up (at any rate, here is the link to the original article). Our fellow citizens from the "Occupy thisthatortheother" movement seem to rather hastily assume that their much vaunted target (among other things the greedy 1 pct of income earners) are all somehow to be found in the financial sector. Or maybe that all finance workers are actually in the top 1 pct of income earners. It probably doesn't matter which way round. It would also appear that facts won't get in the way of a good bit of demagoguery. Unfortunately, however, if you did take about 10 minutes to think about who the richest / most income earning 1 percent are it might become apparent that you are tarring an awfully diverse group of people with a somewhat broad brush when equating them with SATANIC BANKERS. Just have a quick look at the attached graph and the presumption that 1 percenters are the root of all evil might just look a little less convincing than when it was spray painted on some banner. I for one would rather want medical professionals to be paid well. Or lawyers for that matter. Well, at least the one that is representing me. I kind of believe in the notion of incentivising people for excel by offering larger rewards for superior performance. But I suspect that I won't be able to convince somebody who decides that the best time to demonstrate against capitalist greed is the weekend. WTF? And yes, I know this is a US based statistic, it's based on income tax not income etcetc...but it probably is a decent proxy for what I'm trying to say.
Mind you, maybe these upstanding folks with the ethnically diverse musical tastes and questionable hairstyles are not just objecting to finance professionals to be in the top one percent of the money making fraternity, maybe they object to the very notion that anybody should be in the one percent bracket. Last I checked, however, getting rid of the top one percent of any distribution only really works if you flatten the whole thing out more or less completely. Last anybody tried that everybody ended up wearing rather dreary boiler suits and would've made George Orwell both proud and distinctly uneasy. Oh, and they gave it up when they figures it didn't really solve their issues. Go figure, China. Anyway, looks like ideologues have all the answers and as such they don't need to care too much about arguments. Or as Billy boy was putting it: they don't need to care about how the opposition is doing. Almost makes me wonder why I am. Before I leave you to meditate on it all, just remember, true 1%ers do not wear pinstripes. They look a bit like this:

Grade A Banker

Katy Perry, pink latex, death metal and Gordon Brown

I was going to write something about Gordon Brown topping out the league of the world's most devastating rogue traders but then I got side tracked. Sorry! I hope this is suitably weird recompense.

Gunfire, nazis, randomness, statistical analysis and a mediocre Iron Maiden song

Apologies, linking up somebody else's nifty work hardly qualifies as a post, but I'm just too knackered for a proper rant today. At any rate, I love this piece. If you ever thought statistical analysis was irredeemably boring, this should change your mind. Or maybe not.

And here's a picture of Eddy...can't believe it's taken me until now to get one up!

Goldman Sachs doing God's work. Or something like it.

This is just so deliciously fucked up, I don't have any further comment.

Drain you of your sanity; face the thing that should not be! – On the retardedness of the inverted CDS curve

Restating your PnL? WTF!!!

We all know (or should know by now) that when the revolution finally comes all manner of folks will be put against the wall. Now, the big fear I have is that no one is going to ensure that risk managers are rounded up and get their dose of revolutionary fervor. The problem is that it’s just that is an occupation so obscure that the average neo-communist revolutionary / not-so crypto idiot with an AK-47 will simply fail to spot what reactionary fiends of the night / capitalist technocrat lackeys risk managers really are.

But why the special attention to risk managers I hear you ask? What makes them so deserving of revolutionary wrath? Well, basically because they don’t really do their job! The point of a risk managers’ existence is ostensibly to ensure that a bank’s risk book is run within parameters that ensure the risk reward ratio is acceptable and that book is actually valued sensibly in accordance with a pricing policy. And that’s exactly what I’m going to moan about today. The fun and games that kept all manner of financial type and politicians awake over the last couple of weeks have given ample illustration that these risk books are still very much marked not to some rational or even just explicable standard but basically marked to some make believe figures that ensure we all get paid at the end of the year.

The proof? Enter the retardedness that is the inverted CDS curve. Basically, in financial market parlance an inverted CDS curve is taken to be a reasonably sure-fire sign that a financial entity (i.e. the one the CDS in question relates to) is in DIRE TROUBLE and likely to IMPLODE. Why? What does that all mean? Well, a CDS curve consists of a series of points (spreads) that express the expected default risk of a financial entity between now and a future point in time. In more orderly times a CDS curve is upward sloping, that is the spreads (and with it the implied likelihood of default) increase the further your time horizon reaches into the future. Which kind of makes sense. All things being equal the second law of thermodynamics (among a few other things) would indicate that the longer something goes on the more likely things are to fall apart. So what happens when markets are in distress? The reality is that when sentiment turns against somebody (like the US Government during the unspeakably childish debt ceiling squabble in Washington DC) you’ll find it hard to execute trades with longer dated maturities. People simply don’t want to take on the risk of longer maturities. At the same time the nearer dated maturities (that you still can get a quote for) will command a higher risk premium, so the spreads will rise. Now, by convention the maturities for which you can’t get a new price will be simply be staled (carried forward from whenever you last got a quote for them) while the shorter maturities for which you still can get a quote will rise. So what can happen in this particular scenario is that you can get an ‘inverted’ CDS curve, where the nearer dated maturities have a likelihood of default that is higher than the further dated ones. Fair enough you say? You might think so; after all it would look like you are making use of the most recent data that you have to build that curve. So what’s the harm? The harm is that those curves are used to price existing CDS transactions on banks’ books and that’s just plain retarded. Think about it: the risk of a default occurring between now and a future date as expressed by a CDS spread is a non-Bayesian event. The timeline observed for the determination of a credit event (default) is continuous and once the event occurs it will trigger ALL Credit Default Swaps that are referencing this particular reference entity. So there is something deeply and disturbingly wrong with a situation where you have a curve that would imply that the one-year default risk of a company is lower than the five-year default risk of the same company. While I agree that this topic has distinct overtones of needless sophistry / intellectual masturbation about it, it actually is a pretty good indication of what is wrong with modern finance. It’s a bit like that early morning nose-bleed so prevalent among punk bankers and almost-made-it rock stars; not exactly shocking in its on right but clearly indicative of a big old problem. Something is indeed rotten.

James Hetfield totally rocks!

So, to come back to my point about why risk managers need to be brought to the front of the queue when the masses rise up against the system: What does that have to do with inverted CDS curves? It’s simple, it’s those guys that are using just those curves to value the credit books, thus plainly misstating the true value of said book (or lack thereof!). Strangely enough there is zero outcry over such egregious use of sleight of hand accounting to give the illusion of greater stability in the financial system than there really is. I doubt that is because the issue is too difficult to grasp. It really isn’t. But it is sufficiently obscure to be swept under the carpet. It’s not exactly something Robert Peston will be able to blitz the BBC Newsnight viewers with in a 90 second sound bite designed to excoriate bankers and whip incredulous middle-class viewers into a frenzy of polite incredulity. In a nutshell, if your job is to manage risk, you probably shouldn’t be in the business of downplaying the volatility of a risk book. But then again that’s probably saying more about the way incentive compensation is calculated than what is truly sane. Never mind. Move on, nothing to see here. Go back to shopping for some Apple products.