Volatility rules!

VOLATILITY is a bit of a speciality of mine.  When natural gas was first traded, that was in the teeth of assertions from certain no-nothing economists, purely on fallacious a priori grounds, that gas was a "paradigm case" of a commodity that could not be traded.  The market price routinely exhibited vol that was unparalleled for a liquid traded asset (barring the odd rogue stock), and the economists crowed: there you go, this is set for crash-and-burn.  But as the market matured, and was self-evidently not crashing / burning, and the vol persisted ... it became apparent that it was a feature, not a bug, for which reasons can be adduced.  The maths of gas market price-formation and vol was quickly established, and everyone with a stomach for roller-coasters settled down to enjoy the ride.

When electricity was first traded, well, that was considered  even more deeply impossible by the aforesaid eejits.  And electricity prices manifest vol that was completely off the scale - some three orders of magnitude higher than previously encountered anywhere (except nat gas - just one to two orders higher).  And the maths of elec price formation proved much more difficult to establish.  But established it was, and off we went.

It is first-hand experience of all this that informs what follows.

1.  Volatility is like heartbeat, or (switching idioms) friction.  No heartbeat = no life.  No friction = no traction.  But too high a heartbeat, and you're also looking at death.  Too much friction, and you are looking at everything grinding to a halt.

2.  Some folks benefit from vol:

(a) those who've placed market bets on vol, which is fairly easy to do if you understand financial derivatives.  Easiest of all, for stocks & shares there is the "fear index", a.k.a the CBOE Volatility Index (VIX).  Needless to say, this is riding high right now.

More generally, for those to whom these terms are familiar, you can put on long calls and an equal number of long puts, with the strike-price either at, or either side of, the current price (depending on your precise strategy and how much premium you are willing to pay).

(b) those who've invested in 'flexibility' assets, a.k.a optionality in the financial jargon; e.g. (in my neck of the woods) a flexible oil refinery (which can benefit from volatility in the prices of crude oil and finished products); a flexible gas-fired power station (prices of gas, power and carbon); a flexible gas storage facility or electricity battery (prices of gas / elec now, and forward prices of gas / elec for forward time periods; a flexible power interconnector (prices of elec here, and over there) etc etc etc.  As vol goes up, the value of your option-asset goes up.  As Black & Scholes proved, in their Nobel-prize-winning work, vol is a primary component of option value.

 3.  For everyone else, high vol, like high friction, is unequivocally a cost.  And eventually, when we reach the upper end of the heartbeat / friction spectrum it weighs on everyone.  The cry of "risk off" goes up, and big players withdraw from the market, at which point another critical variable - liquidity - starts to loom very large.  There are b-a-d things down that path, too.  Don't let the know-nothing optimists tell you this is all for the best in a funny sort of way.  It ain't.  It's unequivocally bad.

Much more of Trump's casual lunacy and I think that end is in sight.

ND

The Campbell Betting Syndicate: really, really funny

An important C@W morality tale

If you haven't caught it amongst all the holiday excitement, there's a remarkable story afoot of how Alastair Campbell's son Rory allegedly took a load of high-rolling mug punters for several million quid, and has now disappeared - along with the money, naturally.  It's said he's suffering from the mental stress of it all, naturally, and must be left alone.

If these allegations are true, this is really, really funny.  It merits coverage on C@W because (as well as being hilarious) truth be told, mug-punter "investments" are a perennial source of finance for capitalist ventures the world over.  This is an important morality tale.  It is every adult's job to ensure that they don't themselves join this gravy train, and that they do raise their children to recognize the danger signals.

And the biggest danger signal of all, flashing away in lurid neon lights, is - "I've got this infallible system ..."!  For Pity's sake, a betting syndicate!!  Or, as we should correctly term it, just another Ponzi scheme.  With the outside chance that things work out in the short term, but are guaranteed to crater when, as always, betting against the house doesn't work out in the long run.

Making things more delicious than usual, the endlessly entertaining, worldly-wise Campbell senior (+ Mrs C) seem to have sunk quite a bit of dosh into it[1] themselves.  We all hope they got out in time ...  *Ahem*. 

Was Campbell Jnr betting against the house?  Well, details are scant, but I think that's what we must infer: he and his oh-so-mathematical "system" [2] thought they knew better than the big Asian bookies, where liquidity is such you can go large without moving the market.  Well, it is indeed sometimes realistically possible to know better than the odds on offer in a big market[3].  But if you're so damn' smart, the risk-free approach is to arbitrage, not simply to indulge in naked speculation[4].  And then ... there's credit risk on top!  Not only might you not know better than the market - when you do come out ahead, the bastards might not pay!  Which is what, we are told, happened here.  I mean, an online bookmaker in the sub-continent?  Well well well.

Just to round off, read the last couple of paras in that story - the pugnacious press release.  This story, we are angrily told, is one of outrageous breaches of confidence by Master Campbell's investors, which naturally causes the former to withdraw his offer to compensate the latter.  It's all their fault, as anyone can plainly see.  

I wonder who on earth drafted that?  The old master is losing his touch, methinks.

We'll have our own fabulous C@W speculative venture here in a day or so ... the 2025 New Year's Predictions Compo!  Watch this space.

ND

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[1]  It's not wrong - indeed, it can be truly honourable - for friends and relatives to back their nearest and dearest, of course: I've done it myself several times.  But only on businesslike terms that delude nobody, and satisfy everyone before, during and after.

[2] 'Mathematical' systems are the worst.  Very few people really understand probability.

[3] I have a friend who genuinely makes serious money on the horses - or did, until he was no longer physically mobile enough to work his energetic system, which is as follows:

1. study the form, exhaustively.  There's plenty of good data
2. go to the track on the day, and check out the horseflesh for yourself in the paddock.  It doesn't take much experience to spot a horse that is lethargic, skittish, spooked etc
3. arbitrage[4] the on-course odds (knowledgeable) against the Tote (mug punters watching a TV screen hundreds of miles away; sentimental betting on names that sound nice etc etc)
4. rinse, collect, and repeat.

This does entail a very busy afternoon scurrying around, however - plus a little bit of instant arithmetic.  And the credit risk at UK race meets is pretty low.  Incidentally, my man is always willing to be completely transparent: if you can keep up, he'll give you a precise running commentary as he puffs up and down, and you can emulate his every move - if you're quick enough.  Sadly, his puffing days are over.

PS:  the very fact that such a method can be successful, suggests to me that UK horseracing isn't particularly bent.  The dogs - ah, now that's another matter ...

[4] Pure arb in horse-racing is quite difficult for anyone except a bookie (or someone in league with a bookie) to do.  So I must accept that  'risk-free' here is too glib.  
 

Why would Lloyds boast about culling risk controls?

Here's a very odd story, that we must surely assume comes from Lloyds itself. 

Lloyds cuts risk management roles in bid to ‘move at greater pace’ 

Bank’s risk assessment method blocking change, internal review concludes ... internal risk structures were acting as a “blocker” to change ... The changes will help the bank in “resetting our approach to risk and controls” and enable Lloyds to “move at greater pace”, according to an internal memo seen by the Financial Times. Mr Nunn [CEO] has been ramping up the pace of change at the bank after setting out a turnaround plan in February 2022.

Well.  First of all, whoever this Charlie Nunn is, waiting more than two years before "ramping up the pace of change" sounds to me like being asleep on the job: a classic "re-launch" so beloved of failing governments and managements of all kinds.  FFS, he became CEO in August 2021!  I'm no revolutionary, but the longest I ever waited in a new managerial job before making changes at pace was about 3 months, and that delay (for such it was) was for a very specific tactical reason.  Ordinarily, it's Machiavelli's dictum that should rule: make your big changes straight away.  Two years is, frankly, pathetic.  (And check Nunn's salary!)

Secondly, what sort of caricature BSD does he wish to be seen as, ostentatiously axing risk management posts?  I'm not really asleep at my desk, I'm a BSD!  Get out of the road, you risk managers!  We'd be making so much more money if it wasn't for you!  Yeah, right.  Two years.

Thirdly, properly construed, the one facet of financial** risk management that can only with difficulty be a positive contributor to doing good business, is credit risk management.  There's only ever bad news in credit: the best that can happen is that counterparty performs its side of the deal!  Which we kinda assumed in the first place, right?  And nobody ever pays you more than you billed them for, and says - hey, keep the change. 

Otherwise, financial risk management should be viewed as potentially a big positive contributor to doing good business.  It is good business you want to do, right?  Or is it a quick speculative buck: book the 'profits' today, grab the bonus and run away?  I start to wonder.

Finally, the joke is, "The shake-up will see 45 jobs removed from these risk teams, equivalent to around 1.5pc of the 3,600 people who work in risk jobs for Lloyds."  In other words, it's trivial, cheeseparing stuff anyway.  

ND 

(PS, I have never been a risk manager, in case you were wondering.  But I have worked with some brilliant ones.  Only in a dysfunctional organisation does RM stymie good business.)

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** There are loads of non-financial risks that fall into the same baleful category: 'operational risk' (- the catchall for a lot of shit-that-can-happen); and reputational risk, political risk etc etc etc. 

Hedging for Whingeing Farmers - part 2

Some valuable practical detail in BTL comments after that last post - very much what I had in mind when writing "very real practical complexities around our simplified account above - which might have made for a genuinely interesting & informative Countryside piece."  Let's take a look at the issues they raised, & some more that I'm chucking in for good measure.

1.  The ability to hedge, even in principle.  (A) Scale.  Jim has suggested the threshold for being able to get into grain futures is 10,000 acres.  There will always be a lower limit (although with spread betting and ETF, that's been getting lower and lower) and certainly I have no better data.  And why shouldn't there be a minimum size / critical mass for any particular viable line of business?  We scorn the pitifully small energy suppliers (well, I do) for their lack of capitalisation, and wonder WTF they got a supply licence from Ofgem in the first place.  Why shouldn't some industries be for the competent Big Boys?  Nobody has a God-given right to set up a "craft" blast furnace just because they fancy.   

1(B).  Credit.  - maybe thought of as an aspect of 1(A), but it's a distinct issue.  It's always the case that a non-creditworthy counterparty (however large) can't get an OTC forward contract.  That's because payment may become due either way, & maybe they ain't good for the potential monies due.  Of course, if you're trading on an exchange (futures), you'll need to put up collateral and pay ongoing margin (if your position is moving out of the money) to minimise the credit risk.  That again may exclude some players if they can't put up the table money.  Again - so what?   

2.  Weather.  As raised by a couple of you.  Yep, this is one of the 'operational risks' that actually has little directly to do with hedging the financial exposures involved (though see 3. below on volume & Basis).  Weather risk will impact on farmers irrespective of market risk - it can impact adversely on timing, quantity and quality.  There was a time, in the late '90s / early '00s, when lots of people believed a big market was going to develop that would offer 'weather derivatives', there seemingly being a vast potential range of applications for such products.  It never really took off (for reasons we might discuss in another post), despite many big players putting in a lot of time, money, people & effort go get it going.  So:  as was mentioned BTL, insurance always was, and remains, the first recourse.  

Insurance, BTW, should always be anyone's fallback if they can't get a satisfactory hedge - and not just for weather, and not just for farmers .  No credit issues, except that naturally you need to be able to afford the premium upfront.  I say 'no issues' but of course as the client, you always have concerns over the creditworthiness of the insurance provider.  it's a heavily regulated sector, for that reason.

3.  Volume.  (Also mentioned BTL.)  Being subject to several unknowns - weather being perhaps the biggest - how does the farmer know exactly how much by volume to be trying to hedge?  This volumetric uncertainty is an intrinsic feature of some sectors, while virtually unknown in others.  The answer, as far as it goes, is easy:  pick a sensible, maybe conservative estimate, and hedge that.  You're then exposed on the balance, be that long or short.  Coupled with weather insurance, it's the best you can do.

4.  'Basis Risk' generally.  In markets where volumetric risk is small (& hence not requiring a whole risk-management discipline of its own), it would be viewed as a subset of the more general category of 'Basis Risk' - where there's an element of exposure remaining even when you've hedged the best that anyone can.  It can arise from a heap of different factors impacting the 'basis' of your hedge vs the basis of your own situation, e.g.:

-  the forward / futures contracts are only traded in lot sizes that don't allow you to create a perfect volume match;

- the settlement of the traded forward / futures is at a location and/or date that doesn't perfectly match your own locational / timing situation;

- the settlement is for a quality or grade of product that doesn't perfectly match that of your own product (e.g. a very special grade of oil for which there is no specific forward contract).  

That last point - quality - was indeed specifically raised in the Countryfile prog - about the only interesting thing that was aired.  They said that weather could affect what type of grain the crop would turn into, in terms of how it would be viewed - and priced - in the market.  I hadn't known that, but it makes perfect sense. 

*   *   *   *   *

To my mind the Countryfile team should have been at least mentioning some of the above, just as they very fairly (and in an easily-understood manner) alluded to the Basis risk of the quality uncertainty.  It's the job of TV to make these things accessible, and the whole of it is no more difficult than the quality point.

Finally, though, we get to Sobers' really interesting - and quite technical - comment that, courtesy of outrageous hanky-panky on the part of the hedge-providers, for the farmer to enter a forward / futures contract they are in practice writing a naked option.  If that terminology doesn't mean anything to you, well (a) I think Sobers explained the essence of the problem well enough, in lay terms; and (b) writing a naked option is about the most dangerous thing you can do in financial trading.

As many of you will know, agriculture isn't my sector.  I've already noted that small players needn't expect to find things just as they'd like them in any sector, so maybe this is really just another manifestation of 'too small'.  That said, to me it's a pretty shocking matter when, within an industry where quality matters so much, there aren't objective standards and assays that can be relied upon for both parties.   The whole of trade finance depends on it.  WTF should agriculture be different to energy, or metals, or pharma?  Yes, fraud happens in any industry, but what Sobers reports is daylight robbery & very depressing.  Is it really a problem for bigger farmers?  In principle there would, IMHO, be a huge opportunity for large, honest players to step into this situation charging a very modest premium for a proper service.

ND 

The BBC & the whingeing farmers of Countryfile

Hansen & partner: disingenuous whinge

The Beeb: everybody has their favourite gripe but where to begin?  From down on the farm at the highly regarded Countryfile, here's just a little straw in the wind.     

Adam Henson is one of their primary reporters, and evidently a genuine (and seemingly prosperous) farmer to boot.  So a couple of episodes ago, he's discussing with his "business partner" the generic farmers' problem of money, that vital perennial crop.  Here's what the two of them say (20:12 mins in):

"The trouble with grain is, it's a world commodity price ... we don't determine the price at all ...  Geo-political factors like the war in Ukraine ... Fertilizer costs ... Volatility ... A change in market price can cost us thousands ... It's pretty scary, really.  We've spent all the money, we've got a reasonable crop here ... when we decide what to grow, we're gambling on what each crop will be worth come harvest time ..." 

Oo-err, missus, sounds really scary.  Volatility!  War in Ukraine!  Changes in global market price!!   You'd never guess that this has been the farmers' oldest problem for millennia - and, equally, has been solved for a very long time indeed.  

For those unfamiliar with the basic principles of hedging and financial derivatives: whenever a player takes a fixed-price forward position (here a farmer, investing in seed etc at fixed cost today, but effectively playing in the forward cereal market against delivery at harvest time) in a market where prices are liable to change, that player is exposed to potential adverse movements in price.  They are of course simultaneously exposed to the upside of potentially favourable price movements; but it's the downside risk that mostly concerns us (and, seemingly, Henson) here.

Is this exposure necessary?  Not for a very long time, since the ages-old development of forward markets:  why doesn't Henson avail himself of the forward market for the cereal he's investing in?  In other words, forward-sell all (or at least a large part of) his crop at the very same time he buys his seed?  Putting matters simply (we'll note some complexities later), one generally assumes that at the time of his making the fateful decision, there must be a positive margin available to him, i.e. between his fixed costs and the forward value of the crop - else why is he even considering it?  So, courtesy of forward prices, that margin is there to be locked in, eliminating first-order Price Risk.  Now, his risk profile is mostly that of the operational risks associated with weather, blight etc - the very stuff of farming, even for a player bewildered by the financial markets.

Does Hansen not know this?   I think he must.  So why does he bleat in such a dumb fashion?  More to the point (since farmers always whinge & we all know this), why don't BBC editors intervene, & make him say something more comprehensive & honest?

Later in the week we'll take a look at some of the very real practical complexities around our simplified account above - which might have made for a genuinely interesting & informative Countryside piece.  But for now, let's notice how Hansen and his mate signed off.

"as a fairly large farm, we can afford to take some gambles ... "

And there we have it - the pair are gamblers! - which is the proper term for anyone with a forward-price exposure and the ability to hedge, but who doesn't in fact avail himself of the hedge.  Next time: how some of these issues play out in the Real World.

ND

"The Only Free Lunch ..."

A couple of weeks ago I did a piece on Black Swans involving some technical stuff on risk management, and someone asked if there was more.  Well indeed there is ... and this morning I'll pick up on some of the issues raised by our discussion on attempting to envisage some rational basis for determining a logical quantum of self-sufficiency or, as Mark Wadsworth put it, the "efficiency vs reliability" debate.

We can readily agree that full self-sufficiency is an implausible national goal.  It lay at the heart of North Korea's Juche *philosophy*, and look where that got them, even as they remain dependent on China for all manner of important things.  As one of our esteemed Anon's said BTL, "... trade vs self sufficiency, surely it's not an either/or proposition? The sin would appear to have become so reliant on single sources, which has many sources of blame, including the 'lowest price' mentality".

In normal times, it's positively beneficial to procure almost anything from multiple sources.  When one lets you down, the likelihood is another will come good.  Plus, you tend to get better prices because (a) you shop around and obtain good price discovery; and (b) suppliers quickly find you're not a mug.  (Obviously, if we thought to add Australia to our list of toilet-roll suppliers, the transportation costs would overwhelm the benefits of competition in that particular case.)

The price benefit can be real enough, but just as important is the risk-management principle involved - diversification, sometimes known as the only free lunch.  Describing it technically, we are relying on the variables of failure of each source of supply as being less than 100% positively correlated.   The maths involved here is Portfolio Theory, and it's an exceptionally important principle - at its simplest, well known thoughout the ages.  You can find it in the Bible (Ecclesiastes 11:2, v6), Shakespeare (Merchant of Venice); and Churchill famously stated "Safety and certainty in oil lie in variety and variety alone". (He was referring to his policy of sourcing oil for the Admiralty from more sources than just Persia, which had been the case in the early years of RN steamships.)  Not my job to advise anyone on personal investment, but everyone needs to bear it in mind: it has a role to play in every portfolio, large and small.

The second part of Anon's comment was also on the money.  "Perhaps it's time to start have rules on what %age of a good can be sourced from a single, foreign, nation or economic bloc? Security, after all, comes from plurality. Self sufficiency just changes *who* can take you hostage, rather than remove the threat. Add to that a minimum amount sourced internally, even it means having a nationalised source, with the capability of scaling up where possible, allows for flexibility and security of materials?"  This is exactly what happens in a good commercial risk-management regime - rules such as "no more than 20% of our business with a single counterparty" are instituted.  Quite a lot of valid maths can be put into this, to come up with something "optimal" - under a given set of assumptions.  The key, of course, is to price in the risk, to counter Anon's issue of going for the lowest (nameplate) price. We may return to risk-pricing on another occasion, if we've the appetite for even more technicalities (when we've nothing better to do in lockdown ...)

A free lunch ... but when the custard really hits the fan, variables that were heretofore less than perfectly correlated suddenly become highly correlated, all in the same direction - downwards.  If Tesco has run out of toilet paper, so too has Sainsbury - and it ain't a coincidence.  At this point the maths no longer helps us, and we're down to inventory, improvisation, *requisitioning*, sauve qui peut ... and ultimately, privation.

Thus far, Covid-19 has mostly exposed lack of diversification in medical supplies of various sorts.  There's every reason to believe that, as the months wear on and the tide recedes still further, we'll find who's been swimming without trunks on a lot more beaches.  Starting with food ..?

ND

Ride a Black Swan

One of the many great things about Enron, long before it went under, was that it brought really strong financial practices into the energy industry and made people take financial risk management (FRM) seriously.  We can talk about the rich, deep ironies another time.  I was never a risk manager myself, but was strictly schooled in its principles, technical and pragmatic, the better to negotiate sound contracts (which is my trade).

One of the interesting aspects of FRM is that no commercial institution, even a bank, is held to providing 99.9% certainty in its hedging etc - not even 99% in fact; because it can't be done using shareholders' equity without crippling economic cost.  Everyone knows that 100% physical safety is impossible - the cost of moving from, e.g. Five Nines to Six Nines is prohibitive - and likewise that extreme financial events happen out in the "fat tails" of the distribution, that can't really be catered for within the economics of an enterprise in the same technically-sound ways that can be implemented out to two standard deviations.  But what if folk are deeply risk averse, as they surely have the right to be?  The textbook solution to this puzzle is that they must take (partial) responsibility for their own FRM, by diversifying their exposures.  Not everything will go pear-shaped simultaneously ...

Except of course when a Black Swan glides onto the waters.  At this point, hitherto non-correlated risks all become correlated, in the shit-direction: so Diversification fails (as well as hedges not performing and insurance not paying out).  And then we are down to the last resorts:  burning through capital reserves (which were anyway set at the 95% risk level, so by definition they don't go far enough), and then ... socialisation.

Now as CU said the other day, 2020 looks like making 2008 seem like a picnic.  (E.g., I had a massive hedge on against 2008, and it paid up.)   This time, it's straight through to socialisation, and pray God that good decisions are made.

A lot of Socialists are drawing understandable (sort-of) but very wrong conclusions.  Wonderful, they say - and let's keep it fully socialised thereafter because Capitalism Doesn't Work.  This is the merest crap.  I won't rehearse what a feeble-minded misunderstanding that represents as regards What Capitalism Is; suffice to say that they were saying the same thing at the outbreak of WW1, and WW2 (and in fact every day of every week).  It was equally ridiculous then as it is now.  We socialise against the Black Swans, the Kaiser, the Nazis, the C-virus.  And in normal times, we optimise our affairs intelligently.  Leftist snipers can f*** off, and do something useful in the community. If they know how.

One more weekend thought for now.  The EU can f*** off, too.  Their threats will have no force whatsoever, when negotiations recommence.  What, they gonna threaten us with a 1% hit on GDP?  Shortages in the supermarkets and bread riots?  By then, we'll have solutions for all that stuff - and quite possibly better ones than theirs.  Small comfort right now, but I'd confidently say we'll get a sensible deal quite easily - with whatever's left by then.

Keep safe, all.

ND

Gas, Eggs and Baskets

I have a fair amount of time for Michael Fallon (pity about the EDF nuke deal), but ...

"We are looking for more long-term gas supply contracts with Qatar – they have proved a very reliable partner," Mr Fallon told The Sunday Telegraph. "It's very important we strengthen our relationship with them."

A bit close to, errr ...

Hmm.  The article goes on to say that LNG accounted for 28pc of the UK's gas imports last year**, 98pc of those from Qatar.  Reliable, yes - but the geography is worth considering, too.

Diversification is kinda important, Mr F.  As Churchill said à propos of the Navy's one-time near total reliance on oil from Persia: “Safety and certainty in oil lie in variety and variety alone.”

ND

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**I thought it was more, actually, but can't be arsed to check just now

That IMF Bank Tax Proposal : Why So Dumb ?

Amidst all the airborne clag and clegg that pervades our lives, the IMF has given the G20 the advice they asked for on new bank levies in the wake of the Crisis, to contribute (at a national level) to the costs of the bail- outs. It hasn't been given much airtime (Brown simply claimed they all agree with him), but it merits a quick look - not difficult, as the main text is less than 18 pages long.

Furthermore, it's mostly qualitative & non-technical, a very easy read, put together by folk who show a lot of basic commonsense and the ability to speak plainly - they slap town the Tobin Tax in no uncertain terms (tough shit, luvvies). There are also the usual handy factual appendices (did you know that the UK's financial sector contributes a lower percentage of total national tax-take than the G20 average ?)

But here's the curiosity. They recommend a 'Financial Stability Contribution' which

"would be paid by all financial institutions, with the levy rate initially flat [on a broad balance-sheet base]"

A flat rate ? Bonkers! Particularly as they then make the obvious point that we are trying to address risk: they say the levy could be

" ... refined over time to reflect institutions' riskiness and contributions to systemic risk"

Their excuse for this dumb flat-rate approach is of course speed of implementation: but they really aren't doing justice to the capabilities of the existing system. Financial institutions are well used to risk metrics: they all calculate some variant of the standard 'Value at Risk' measure, and are accustomed to having margin levied on them by exchanges using SPAN or an equivalent risk-recognizing system.

We can do this stuff already. Aim straight for the target, regulators, and go with a risk-based measure from the start - never mind Taleb and his Black Swan sophistry. It is rather important to get this right first time.

OK, now back to politics ...

ND

Bankers: Apologies Fake, Stupidity Genuine

It’s easy to diagnose greed and assorted wickedness from the Select Committee hearings – for example, the whole outrageous Paul Moore / James Crosby saga that, as CU says, will rightly run and run. (CU UPDATE: Crosby has resigned from the FSA this morning)

But I want to highlight another aspect – the circle-jerk phenomenon where everyone is, err … drinking each other’s whisky and gets completely carried away. Hornby says he invested his bonus ££ in HBOS shares (and has thereby lost a packet), and Goodwin avers he never sold an RBS share.

This exactly mirrors the behaviour of almost all the senior Enron execs, most of whose personal wealth was in Enron stock, and similarly sank with the ship. The notable exceptions were head trader Lou Pai, who (uniquely) insisted on being paid cash bonuses: and the actual criminal mastermind Andy Fastow, whose ill-gotten gains were invested in … municipal bonds (well, he knew the score better than anyone). Which kinda suggests that the rest were not calculating crooks, but were swept along in the excitement of the whole adventure. Ditto Hornby and Goodwin, by the same token.

This is doubly remarkable, because as any banker (and Enron exec) should know, the first paradigm of risk management is Diversification (the other two are Hedging and Insurance, BTW): indeed, in RM circles diversification is known as the only free lunch. These guys were so caught up in what they were doing, they ignored first principles, even in their own personal decision-making. They weren't just being reckless with shareholders' wealth, but with their own as well. That’s how intoxicating the game becomes.

And this is why we need regulators that are permanently ready to intervene. And this is why politicians who instruct regulators to turn a blind eye (Brown, Blair, this means you) are utterly, utterly culpable.
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Footnote: a couple of interesting comments from the Grauniad’s Dan Roberts in their live coverage, one perceptive, the other unbelievably crass:

“McKillop and Goodwin have so much gravitas about them that you can almost see how they managed to con us all out of billions of pounds”

“They've now wasted best part of half an hour on an arcane row about a supposed whistleblower at HBOS. I wish we could get back to the meat”

ND

new footnote: Alex (comments) points to an alternative account of how Lou Pai made off with his Enron dosh