Emperor finance’s new clothes


I can never quite take the high flying world of finance seriously, or worse, I somehow don’t quite believe it exists. I have a sneaking suspicion as I watch the parade of bankers, finance ministers, and industrialists in their beautifully tailored suits, that what I’m really seeing is a bunch of aged and overfed streakers. The crowd around me seem entranced, so perhaps I’m not the right person to be writing this article.

Is it real? Here’s London’s Financial Times:

According to data released by JPMorgan this week, total issuance of CDOs [Collateralised Debt Obligation] – repackaged portfolios of debt securities or debt derivatives – reached $503bn worldwide last year, 64 per cent up from the year before. Impressive stuff for an asset class that barely existed a decade ago.

But that understates the growth. For JPMorgan’s figures do not include all the private CDO deals that bankers are apparently engaged in too. Meanwhile, if you chuck index derivative portfolio numbers into the mix, the zeros get bigger: extrapolating from trends in the first nine months of last year, total CDO issuance was probably around $2,800bn last year, a threefold increase over 2005.

So the bankers created 2.8 trillion dollars out of nothing in 2006! That’s about equal to the whole of the third largest economy in the world: Germany. That money was lent, interest was charged, people bought things with it. They bought US debt, they bought resources, but most of all they bought corporations.

It was the greatest piece of money magic we’ve seen since the invention of options trading, and it’s quite interesting to see how it was accomplished. Here’s the Financial Times again:

[An anonymous senior banker] relates the case of a typical hedge fund, two times levered. That looks modest until you realise it is partly backed by fund of funds’ money (which is three times levered) and investing in deeply subordinated tranches of collateralised debt obligations, which are nine times levered. “Thus every €1m of CDO bonds [acquired] is effectively supported by less than €20,000 of end investors’ capital – a 2% price decline in the CDO paper wipes out the capital supporting it.

“The degree of leverage at work . . . is quite frankly frightening,” he concludes. “Very few hedge funds I talk to have got a prayer in the next downturn. Even more worryingly, most of them don’t even expect one.”

It looks to me like a system where all the people who might raise the alarm have their heads so firmly in the trough they’ve no incentive to think about the potential for disaster.

I have a theory that in the real world none of this matters in the slightest. The sun will still rise, the crops will still grow. If the people who buy and sell and make actual physical things were to totally ignore the bankers and the finance ministers and the CEOs then the everything would continue as before – except that the sun would shine slightly more brightly and there would be a spring in everyone’s step. Unfortunately this ability to disbelieve the bankers’ illusions has been carefully discouraged over the last couple of centuries and few people nowdays can muster the will.

So we teter on the edge of a catastrophe, one created by the mesmetic hold of financiers over politicians and the consequent deregulation of normal oversight in the world of high finance – sustained by the simple chance that no small child has thought to ask why our betters preen about naked as they congratulate each another on their wisdom and courage.

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