Friday, 1 February 2013

Infantilism over Interest-Rate Swaps

Kerr-ching !
It is possible to envisage the mis-selling of an interest-rate swap - see below - which would be deserving of punitive action.  But has this really happened on the scale we are led to understand ?  I find it very hard to believe.

Interest-rate swaps are not "absurdly complex" products as has been stated - in combination with a floating-rate loan they result in a fixed-rate loan.  What sort of businessman borrows millions who cannot understand this ?  And a 'collar' is only a tad more difficult.

We read that some borrowers were told there would be no loan unless they took a swap.  This means, the bank in question was unwilling to offer a floating-rate loan.  But (for various reasons we could go into) they frequently have a practice of quoting on a floating-rate basis, and swapping it out when the loan is agreed.  The two-step process is a bit unnecessary, perhaps, but it's how things are often done (and not just for loans - it's quite usual in energy contracts, too).

So - a very simple product, sold in a somewhat redundant two-step way.  And yet we are told that 90% of the borrowers hadn't a clue what was going on - to the tune of £10 billion in compo !  Someone's surely avvin' a lucrative laugh: and we are allowing the Great British Businessman, Mr Diddums, to walk away from any responsibility for his own affairs.

So what would have to happen for genuine mis-selling to occur (which, to repeat myself, would certainly merit redress) ?  I suggest it would need to be one or more of the following:
  •  the bank rep lied through his teeth, and stated that the swap was in fact a call-option ('cap', or 'ceiling'), and would only operate if interest-rates rose
  • the bank rep asserted strongly and convincingly that interest-rates were definitely going to rise, and that a fixed rate was the best choice
  • the bank rep stated that floating-rate loans were not available anywhere, from any lender
  • it was self-evident the client was as thick as shit, or spoke no English whatever (see below)
  • the loan was much bigger than the client needed 
  • the strike-price on the swap was way off the money (in the bank's favour) at the time the deal was struck
If 90% of customers can demonstrate one or more of those, I shall be very surprised.  They will take the compo anyway, of course, and a new claims industry will be born, adding several points to GDP growth.

Footnote: these little cameos from the Telegraph make interesting reading.  I particularly found the case of the non-English-speaking Turkish patisserie owner instructive.  Taking the numbers cited at face value, Mr Bey must have borrowed several millions.  Quite a patisserie, I'd say.



Blue Eyes said...

A good rule of thumb: if you don't understand it, don't buy it.

measured said...

BE, is this the case where the patisserie should have stuck to plain vanilla?

Couldn't resist.

Blue Eyes said...

Ooh yes, highly approve of cake jokes.

Bill Quango MP said...

I had endless trouble getting a fixed rate. In the end had to take floating.

As luck would have meltdown..etc.

Kynon said...

Measured/BE - perhaps the chap thought he could have his cake AND eat it?

Richard Brown said...

You appear to be assuming that the floating leg of the swap in some way mirrored the floating rate loan. Is it conceivable that they were not aligned?

e.g. I've seen some commentary that the duration of some of the swaps sold exceeded the term of the loan - but if the payments on the floating leg diverged significantly from the payments on the loan, I can see why people could feel misled (e.g. if the floating leg tracked LIBOR in some way but the loan interest itself reduced far less significantly when the BoE dropped rates, etc, etc)

CityUnslicker said...

Richard that is certainly true of the bigger loans, that the swaps and loans were not tied.

This blew up Punch Taverns as I recall. Basically treasurers going betting with company money.

Whilst ND is in the main correct, the main issue he yet again is the Government moving the goal posts to suit the day.

Like PPI, its was quite legal to sell these products, now many years later it is not.

I fail to see how the banking industry can really recover if at any time regulations can be changed retrospectively that adversely challenge them. I won't be buying any shares in them and on this one issue, I have massive sympathy for them.

Having said that, i have seen docs where the customers said they did not want the derivative and were told they had too. As all providers were doing the same, the market was broken. This is nowhere near 90% of cusotmers.....

Richard Brown said...

@CityUnslicker - thanks. Agree it is inconceivable that 90% of purchasers were misled.

Electro-Kevin said...

Measured - Until there was rum & raisin there was nothing wrong with vanilla.

Now no-one is satisfied. And just how do you come down from something like this ???

Completely unrelated but worth 25mins of anyone's time.

Nick Drew said...

if you don't understand it - more than just a rule of thumb, BE - it's the Golden Rule of risk management!

yes, we like cake jokes, especially on a sticky subject like this ...

Richard - yes, an even more basic factor! but we are all agreed 90% is ridiculous

weekend vieweing, I think, Kev

Blue Eyes said...

CU again if the banks were colluding or operating a collective dominance of the market that's (yet again) a competition issue not a "customers forced to buy a product they don't want issue". So I agree with you that the banks are getting shafted for the wrong thing. I also agree about the retrospective nature of it.

We used to be a free-market, rule-of-law country. When and why did that change?

andrew said...

I do not understand most of modern life - cars, mobile phones, the internet, ballpoint pens, paper

Can I have compensation?

measured said...

E-K What a fascinating clip. The Russians had some powerful lens on their cameras clipped to the wall. Thanks.

Kynon, ROFL. I reckon he thought he had got the icing on the cake, but discovered it was in fact only a very expensive meringue.

BE, when bankers lost their morals. There again, they have families to feed and high maintenance wives.

Anonymous said...

Another totally ignorant article of the facts,
I am sure the only people who truly know what occurred in these meeting on swaps were the ones who were present.
What you want us to believe ? , banks don't lie, banks don't deceive, banks always look after the customer. Come on wake up !
Oh and by the way all interest rates regardless of nature are governed in some way by Libor

Nick Drew said...

What you want us to believe ?

oh, I'd believe anything about a bonus-driven bank salesman, anon

however, being of some experience in the hard-nosed world of SMEs, what I also firmly believe is that business folk who borrow millions are rarely complete and utter morons

man who borrows millions and doesn't understand an interest-rate swap, is a very odd fish indeed

and I don't believe they exist in those numbers

but I do believe they'll happily take the compo ...

Gaston said...

Last year we made a video on IRS
Hope you enjoy it
Best regards and great blog!