Paul Jorion's blog

An English translation of Kerviel: la question que personne ne pose posted on my French blog on June 21st. Many thanks to E-blogs for the translation.

What have we learnt so far from Jérôme Kerviel’s trial about the big questions? Do his superiors know more they pretend about the transactions he was doing? Another question we would like to know the answer: is entering fictive operations in the reporting system to hide his positions –as Kerviel says– a common manoeuvre in the traders’ world?

Is it because I had the opportunity to be a trader on futures markets that I don’t really care about the answers? I don’t know. What amazes me on the other hand is why, during the first two weeks of the trial, no one asked what I think is a crucial question, a question that I’d call “à la Lord Adair Turner”, from the name of the president of FSA (Financial Service Authority), British markets controller, who wondered, not long ago, if everything in the financial system was useful from a social point of view.

My question, which doesn’t seem to be of any interest to anyone but me, is the following: how useful were Kerviel’s transactions to his bank? Because, really, choosing the “long” position hoping the price will raise or the “short” one, hoping the price will go down and with “big” amounts of money, what’s the use?

Let’s take a simple example. Kerviel made a bet for Société Générale that could bring in –let’s be “moderate”– one million Euros. And let’s say, to put it simply, that BNP Paribas made the opposite bet. This time, Kerviel wins: Société Générale wins a million Euros and BNP Paribas loses a million Euros. Is it useful in anyways? The answer is yes because dividends and gains of the winner raise and decrease for the loser.

What about us? We don’t really care about that. Except… except if one of the two banks consistently wins while the other one consistently looses. In that case we, as tax payers, will have to save the bank which lost with our own money, bank that of course is “too big to fail”. In others words, what all little Kerviels of the world are doing, and the banks with them is just creating a systemic risk. So, in the end, is that “socially useful”?

Here an English translation of La machine infernale, my monthly column for March in Le Monde – Économie.

A DEVILISH DEVICE

Only five years ago, we were led to believe that the advertised model of the economic and financial apparatus represented a system that was finally mature: stable because thoroughly predisposed to self-regulate and practically safe thanks to super-efficient risk-spreading.

Self-regulation did not happen. Risk, although atomized, was nonetheless concentrated by the more astute players into enormous portfolios of financial products with, influenced by the economic climate, inflated risk premium; an unavoidable downside correction triggered the implosion of the Bear Stearns, Lehman Brothers, AIG, Fannie Mae, and Freddie Mac.

Computers brought complexification to the credit-based world of finances which from then on prevented it from functioning in anything but bubble mode: euphoria concealed the non-existence of self-regulation, while concentration of risk, for a time minimal, went undetected.

By contrast current events highlight the dysfunctional nature of the economic and financial workings outside the dynamics of an economic bubble. Thus, in the case of the speculation against the Euro, a collection of harmful elements combine in a potent toxic mix.

Sometime during 2001-2002, the European Union turns a blind eye to Wall Street’s currency swaps-disguised loans to member states in order to allow them to comply with the terms of the Euro zone Stability and Growth Pact (SGP). Yet, the increasing complexity of financial products makes it impossible for rating agencies to correctly assess the underlying risk. When the subprime crisis breaks in 2007, rating agencies are rapidly discredited. Vague attempts to reform those agencies suffer the fate of all proposed regulations at the time (with the exception of some, sufficiently innocuous): they are shelved into oblivion. Meanwhile, scientific rigor proving elusive, rating agencies will do with inflexibility.

The downgrading of Greece tainted currency swaps put them just a notch above the trigger for a margin call that that nation is unable to honour. Speculation on the, by now, strong likelihood of Greece defaulting gets under way. By taking long positions in Credit-Default-Swaps (CDS), speculators are “insuring” against a risk they don’t face, but by so doing, increase the likelihood that it materializes. Rising CDS prices, considered as an objective measure of risk, according to the prevailing “efficient market” economic theory, generate a proportional increase of the coupon required upon issuance of new debt by Greece, further penalizing her. A vicious spiral snaps in place that nothing can stop. Like so many dominoes, other Euro zone states are being lined up. Once one is in default, the rest of those still unscathed would be weakened, and speculation will immediately target the next most exposed.

When banks were failing, States provided help. The heat is now turned on States. Only the IMF will be left to stage a rescue. On February 26, an announcement was made, through its president, Dominique Strauss-Kahn that the IMF was ready to take up its role. We count on it: the IMF is surely the last defence line.

Many thanks to “bb”.

An English translation of Le capitalisme (I) – Les nervures de l’avenir posted on my French blog on March 2nd.

In Reason in History (1837), a posthumous work composed from lecture notes, Hegel observes that “ … what experience and history teach is that peoples and governments have never yet learned from history, let alone acted according to its lessons”. This is true: had it been otherwise, no civilization having preserved the memory of those that preceded it would ever have died.

While failing to learn from history, men have never stopped however trying to decipher it and when reading it, our focus is either on what keeps reappearing under an identical shape or on what has never been seen before. Grasping to what extent these two ingredients are mixed: the same and the different, is fundamental of course, especially in those times of transition. We will not know where we’re heading if we fail to determine whether the times we live in are characterised by the brand new or by the eternal return. With the former, the processes observed are nearing completion, with the latter, they are bound to persist. We need distinguishing ruptures from continuities. When the first outweigh the second, then change is radical. This is why the ability at reading history is less crucial when in the early days of a new era than when, as currently, an exhausted era is coming to an end.

When cracking a chrysalis, a dark and thick liquid comes to light, revealing neither the shape of the larva in the process of being dissolved, nor that of the perfect insect which will emerge one day. Turbulent times are of this nature. Saint-Just was once forced to admit that: « Perhaps the force of circumstance leads us to outcomes which we had not thought of ahead. » Shortly after this admission, he surrendered without a fight to a fate of impending death, acknowledging his inability to understand the whirlwind that had overtaken him.

Should times evolve in a radical fashion, there will exist within them « veins »: rectilinear trajectories connecting the past to the future through the mesh that the present is made of. Other areas will remain unchanged but, for as long as the transition takes place, being part of the general effervescence, they will nonetheless be subjected to disquieting turbulence. Being able to detect the underlying presence of such “veins” amounts to reading the future written as of now in the present.

(To be followed …)

[Thanks to Bernard Bouvet for having had a first shot at translating this piece!]

An English translation of Feu en la demeure !, posted on my French blog on February 25.

Ladies and gentlemen of the European regulatory authorities, I am today turning to you: the house is on fire!

Demands that Greece lowers its civil servants’ wages will not save her. Your prodding Greece to tackle tax evasion will not save her. Your offer to establish a… piggy bank (how laughable an idea!), will not save her either. All that is far too little, far too late. It is also beside the point.

On February 3rd, I happened to be one of the guests on the English show of France 24 TV channel, ”The Debate”. For our sake, I beg you to hear what I had to say when the discussion bogged down on whether or not Greece cooked the books on its economic statistics. This is how I then summarized my address:

I am saying, we are witnessing again someone playing a little game with Credit-Default-Swaps (CDS). But this time, it is not, 1) Bear Stearns, 2) Lehman Brothers, 3) Merrill Lynch, it is, 1) Greece, 2) Portugal, 3) Spain. The doings of the financial markets, these past days, are not unlike George Soros’ coup that sank the British Pound in 1992 (and some think that the economic « science » renewal lies in his hands!).

Your little piggy bank in support of Greece, established after such travails, will last but a few hours in the storm, and immediately following that, four more will be required, one for Portugal, one for Ireland, one for Cyprus, and the next, for Spain, a much larger penny bank than the others put together.

Then, you will have a few days in order to catch your breath, the next target not belonging to the euro-zone: I am speaking of the United-Kingdom.

We are not dealing with wages being too high: what we are facing here a domino effect, in the same way Lehman Brothers’ name was spelled out in the sky the day of the fall of Bear Stearns, so will the name of Portugal be carved in heavens when Greece defaults.

What is to be done? Aim the spotlights towards the source. Towards the lethal combination of national debts rating by credit rating agencies with naked Credit-Default-Swaps positions, those bets taken by some with absolutely no personal risk but in the process creating systemic risks by the tonne, all but for one goal: enormous personal gains.

It is time, Ladies and Gentlemen, to consider outlawing speculation on price fluctuations (also known as financial spread betting).
Do not object it is complicated: it is not, it is already written in the spirit, if not yet the letter, of the Statements of Financial Accounting Standards No. 133 (FAS 133).

Do not mention it is going to affect liquidity: my usual response to this argument is that bettors only create liquidity for other bettors and in that it is of no importance whatsoever. But today I am going to add something else: at the present stage of a probable disintegration of the euro-zone: “Who gives a damn about liquidity!”

(Many thanks to Bernard Bouvet!)

We will ponder: “Might the financial crisis be followed by national crises?”

Alessandro Giraudo – Chief Economist, Tradition Viel (in the studio like myself)
Ondine Smulders – The Economist (calling in from Athens)
A (to be determined) Reuters Breakingviews’ journalist (calling in from London)

Podcasts :

First part.
Second part.

Conceptual artist Little Shiva who helped me design Santa Crisis last year informs me she went to Copenhaguen in her capacity of a polar bear.

Cityislander’s imaginative translation of “La nuit du 4 août” at the French end of this blog. Many thanks to him!

Exactly 220 years ago (the French Revolution), on the night of August 4th, 1789, the question certainly was not about systemic risk. Yet, on that very night, an event of systemic magnitude occurred: the French assembly ended the feudal system and its privileges.

Keeping this historic event in mind, we have to reflect on the fact that we have not yet fully grasped that when systemic risk became an issue in 2007, capitalism wasn’t just going through a rough patch. Rather, it had been mortally wounded. Our politically correct attempts to see green shoots in the economy and marvel at them epitomizes wishful thinking.

The old fashion way to save capitalism, the socialization of losses, proved insufficient, this time to absorb the sheer size of the systemic shock, only matched by the enormity of the debt binge that caused it over the past 35 years. Tax havens had allowed the wealthy to evade the IRS, leaving the middle class to pay for the bailouts. This time, however, the price tag is simply unaffordable.

Without a viable solution, we look the other way and comfort ourselves with the illusion that things will heal over time; a propaganda, that is generously fed by the establishment. Isolated havens of prosperity have emerged, the pitiful benefits of the purported trickle down economics behind the massive bailouts.

The less fortunate were left to face dire prospects on their own, while at the same time the available resources were given in priority to the few banks still standing, thereby confirming the oligarchy theory. Looking back, they seem to have been pulling the strings all along. Lehman Brothers, declared bankrupt on Sep 15 of last year, was a rival of “Government Sachs”. Wasn’t it meant to happen, then?

In the heydays of finance, competition was rife between banks, yet markets were deemed resilient. The high-jacking of capitalism by banks, however, eventually brought it to its knees. With the benefit of hindsight, we’d like to think that everything would get back to normal if only we got rid of the bad guys. Alas, our awakening comes after the fact. The goose that lay golden eggs is gone.

In spite of occasional rallies, under IV therapy by the government, Wall Street’s attempts to resurrect its glory are eventually deemed to failure and will only reflect the desperate attempts of its kings to stick to power.

When the new system takes over, we will not see it for what it is: the replacement of a broken system by a new one. Rather, we will clamor that reason won over a corrupt elite, that drowned in its own excesses.

A reader of my French blog has taken the trouble of translating my most recent Friday video in English. Many thanks to him!

NEWS is conveyed by letter, word or mouth
and comes to us from North, East, West and South” (Witt’s Recreations)

. . . but mostly from the Paul Jorion blog now that we have the Internet.

I want to talk to you about the stock market, because the stock market has been rising in France and in the United States. I am obliged to reflect upon this, because, as I have mentioned to you, I have agreed to prepare an afterword to a new edition of several works of Proudhon concerning stock-market speculation. It is important to understand what is happening at the moment. Does it mean that the economy is improving? To that end we need to look back at the events of the past two years.

In the summer of 2007 we witnessed the drying up of inter-bank credit, by which is meant that the banks stopped lending to one another. I remind you that the reason for this is that there was a depreciation, which began to become quite spectacular from February of 2007, in the value of securities consisting of large collections of individual mortgage debts, because many people were no longer able to keep up their monthly repayments. Consequently, the value of these securities plunged. In the summer an air of general suspicion arose from the fact that banks did not want to reveal whether they possessed these products, which could no longer fetch a price, because there was now no market for them. Everyone in the world of finance suspected everyone else of possessing these products and thus of possibly being insolvent. An unwillingness to lend developed, as no one could be depended on now to be credit-worthy.

I shall remind you of the first measure that was thought of to deal with this problem: the creation of what were known as ‘bad-value banks’ or ‘bad banks’. The possibility was envisaged of putting toxic derivatives into a form of quarantine so that the banks could get them off their balance sheets. So ratios of solvency were worked out, to see whether they were above or below the threshold of solvency. What happened, as has recently become known, is that the British, who were in much the same position as the Americans, came to the conclusion that it was impossible, as it would be too expensive.

The second idea, which was adopted in previous crises, is known as ‘privatization of profits with socialization of losses’. This solution, which had always worked very well before, means that the private sector gets whatever profits there may be when things are going well and then, when things go badly, the state, i.e. the taxpayer, forks out to cover the losses. The novelty in the crisis in which we find ourselves now is that this classic solution can no longer be considered, as that too would have cost too much, the level of debt which had been incurred having exceeded the capacity of states to absorb it.

Read the rest of this entry »

A blog gives you visibility, allowing people from all over with views akin to yours getting in touch. That’s what happened a couple of months ago with conceptual artist, Little Shiva asking: “What about a common project?” I told her of a possible allegory for the crisis, a symbol that you could copy here and there, whose name would be Santa Crisis.

After some going back and forth, here he is: a jolly old elf!

Make him known: that’s the idea. Just inform where he was born: here and there.

Click to enhance.