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”?

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!)

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.

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.

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.

So it was decided to adopt a direct approach which would be less expensive and which consisted in giving money to the banks to help them out of their difficulties. Together with this go what are known as ’stress tests’. You will have heard of the ’stress tests’ that have been carried out on banks in the United States and are to be carried out in Europe too in order to determine which banks may be declared to be solvent. This is nothing but a big public-relations exercise, in fact, as these ’stress tests’ are actually normally carried out all the time. They have always been carried out everywhere in point of fact. So this great pantomime has taken place to persuade people that the banks are now in better health following the recapitalization exercise and that they are now out of trouble.

What has not been taken into consideration is that in the background the economic situation has been continuing to deteriorate. The deterioration resulted from problems in the financial sector, which have led to redundancies, and created a state of affairs in which there are fewer and fewer people who are drawing salaries which are adequate for the purpose of keeping up their monthly mortgage and credit-card payments. The situation in the American property market has continued to deteriorate, not only in the residential sector but also in the commercial one. Problems are developing concerning credit-card loans and all the other loans that build up in American households, student loans, health costs and so on and so forth. So, after having made all of these ’stress-test’ declarations following the recapitalization of the banks, circumstances have changed for the worse to such an extent that, if the ’stress-test’ calculations had been carried out all over again, it would have been found that the banks had again fallen below the threshold determined by the solvency ratio. So what could be done?

There was, in fact, only one solution. Because results had been adversely affected by the depreciated value of toxic securities when they appeared on the surface, all that was left to be done was to start telling lies about the value of these products. ‘Mark to Market’, i.e. valuing them at prices which real transactions would have resulted in – the market price of these products – would have meant valuing them at prices which would have been too low. If these prices had been mentioned in the results of the businesses, these financial institutions would almost all have been seen to be what they were in reality, insolvent!

There was only one possible approach to adopt, and this was to modify these figures to make them seem better than they actually were. The solution which was conceived of for this is what is known as ‘Mark to Model’, i.e. a system of model quotes, which means that, instead of using market prices, one conjures up a scenario in which it appears that all is well in all the markets and then one sells these products on just as they were sold on before. This does not solve all the problems, of course, because, if in the background people are still not managing to meet their monthly repayment obligations, the prices of these products will still go down. But the idea is that this will all sort itself out in more favourable economic circumstances so that the prices will be a lot better.

Was it permissible to do any of this? No, it was not, because rule 157 of the FASB (the Financial Accounting Standards Board), the US institution concerned with accounting rules, prohibited it. So what did they do? The American Bankers’ Association put in place something that they called the Fair Value Coalition. This organization was allocated $27 million, which was used to pay members of the US Congress concerned with the Finance Commission to get these politicians to invite the FASB people to appear before them to be told that they would have to change this rule, and this is what happened, in March.

Is all of this public knowledge? Yes, it is! It was all discussed on the front page of The Wall Street Journal. On the front page of The Wall Street Journal there was even an article which even went so far as to specify the exact sums of money which were paid by the American banks to these members of Congress who are on this finance committee to get them to take this decision. One should add that this sort of thing is not against the law in the United States. These are considered to be contributions which the business community makes to the electoral campaigns of these politicians. So what do these politicians say when they are reproached for having sold out to Wall Street? They issue press statements to say that they have indeed received these sums of money but that this has not influenced their decisions! Mr. Kanjorski, the congressman who was at the forefront of the battle and who was the most forceful member of the committee at its meetings, insulting, as he did, practically all the representatives of the FASB, received over a period of two years the sum of $704,000. I repeat that this is not secret information. It was on the front page of The Wall Street Journal!

So that proposal went through. What has it made possible? The banks have gone back up over the solvency ratio. Why? Because they fixed the prices of these toxic assets not at any old price but in accordance with calculations made on the basis of a model which was established to put everything back so as to permit these products to be sold “at a more reasonable price”, as the American Bankers’ Association put it. So, when they tell us now that the stock markets are doing well, it is indeed true that that is so. But in what context are they doing well? In the context in which the figures are not truly what they are represented to be!

Did they have any choice in all of this? No, they had no choice, because, if they had continued to calculate things as they were doing before, and, given that the money available to governments for the purpose of assisting the banks is limited, there was only one way to prevent the banks from being shown to be insolvent, and that was to adopt the procedure which they opted for, which was to falsify the figures!

What is the problem with all of this? Everyone would have seen that the banks were insolvent. They could hardly let all the banks go bust. Something had to be done. They could have nationalized all these banks and wiped the slate clean. They preferred that pressure be put on the FASB to change the rules, and since then everything has been done in a fog of deception and distortion of reality. On this basis stock markets are doing well. But what is the danger in all of this? The danger is as follows. When it is said that it is important that the banks get back to circulating money between one another so that there is a supply of credit, etc. and that it is imperative that there be confidence in the system, what is meant by confidence? That simply means that a bank needs to know if the other banks that it is dealing with are solvent or not. But now they no longer know, because they have all been told that they may put on their balance sheets whatever figures they care to put there.

So, even though things are bad at the moment, stock markets can still do well, because everyone knows that that is the established state of affairs at the moment. But when a recovery begins, confidence will be needed. However, transparency has been sacrificed. Transparency is needed, though, so that people can know exactly what it is they are dealing with, etc. There is more to it than that, as we know. As Proudhon observed, there is a lot of insider knowledge that makes things work. We also know that volumes are created at present by means of program trading which operates essentially for the purpose of moving money about from here to there and back again to take advantage of the fact that people can benefit from merely creating liquidity, even if that liquidity is being eaten up as part of the same operations, and so on and so forth. But, when things start moving again, if they ever do, everyone will need to know what is what and whom to have confidence in for what purposes. Unfortunately, however, the strategy which has been adopted makes this impossible. Transparency has been suppressed, because falsification was necessary, and that was necessary because the only alternative to it was nationalization, which was not wanted.

So what is going to happen when a recovery takes place? Only one solution is possible. They will change direction. Another $27 million will be found to re-instate the ‘Mark to Market’ arrangement. Why? Because, when a new financial bubble develops, market prices are more optimistic and everything seems to be going well again. So that things do not continue in this way we must demand that this system be brought to an end.

In America, even though many people have buried their heads in the sand there, and in Europe it is being observed that this state of affairs has got out of hand. Even people whom one might have thought of as having a vested interest in what is happening at present in the United States, as well as people such as myself, are saying that a proper recovery is not possible given the present condition of the system. If it is not modified, there will be no transparency, and consequently a proper recovery will not take place. This system cannot proceed as it is. It is broken. We need to find something else.

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.