Winners and Losers
| Thu Nov. 5, 2009 9:43 AM PST
Felix Salmon is back from vacation and he's tanned, rested, and ready. Today he notes that Goldman Sachs and Wells Fargo made big money on interest rate swaps last quarter and asks:
And there’s another question, too: if the likes of Wells Fargo and Goldman Sachs are making billions on these swaps, who’s on the other
side of the trade? Who lost billions of dollars by swapping floating into fixed? Call it the Summers trade, after Larry’s disastrous foray into the rates market when he was at Harvard. It didn’t work then, and it clearly isn’t working now, either.
That's a good question. In fact, I've long wondered about this more broadly: lots of derivatives bets are zero sum deals where winners are always matched up with losers. So if the financial sector is making boatloads of money betting on derivatives,1 which sectors of the economy are the losers?
To be honest, my main interest in this is polemical. It's not that I really care all that much about precisely who the winners are losers are, but I do think that public wrath against Wall Street might be very usefully stoked by learning who's paying off on all these bets. In the case of about $13 billion in CDS winnings from Goldman Sachs, for example, the loser was AIG — and then the taxpayers graciously covered that bet when AIG went bust. But it's not just banks and hedge funds on the other side of these bets, is it? It's also pension funds, corporations, and state and local governments. It would be illuminating, I think, if someone could track the flow of wins and losses in a way that made them a little more concrete for people. Especially the losses.
1Aside from the late unpleasantness, of course. But you know what I mean.
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Comments
Wall Street is a Casino
Submitted by daryl_mccullough on Thu Nov. 5, 2009 10:30 AM PST.
Over the long term, only the house wins, and the house in this case is Goldman Sacks (and maybe a few others).
Daryl McCullough
Ithaca, NY
risk is for the unconnected
Submitted by tpx on Thu Nov. 5, 2009 10:32 AM PST.
In theory, free trade, market economics is supposed to benefit both parties in a transaction, which is usually true. Finance capitalism, on the other hand, creates winners and losers. Winners in zero sum games earn much higher returns than they could in mutually beneficial trade, but they also risk losing everything unless they have already fixed the outcome with fraud or graft. The smart money is easily identified in America, since it has supplied the Dept. of Treasury and the regulatory agencies with managers to ensure it wins.
This is silly
Submitted by Al on Thu Nov. 5, 2009 10:48 AM PST.
Most swaps and collars are not entered into for trading purposes, they are entered into to reduce risk. Goldman and others take on the variable rate risk in order for their counterparties to reduce their risk. It is insurance, not securities trading.
This post is like asking "Geico made $X billion last quarter from their car insurance division - I wonder who lost all that money?" I'll tell you who lost all that money to Geico - everybody who purchased car insurance from them!
"In fact, I've long wondered
Submitted by The real a (not verified) on Thu Nov. 5, 2009 11:21 AM PST.
"In fact, I've long wondered about this more broadly: lots of derivatives bets are zero sum deals where winners are always matched up with losers. "
Well, lots of derivative bets aren't. Consider an option. Usually a client will buy an option from an IB and not hedge it, while the IB will hedge it. So, it is possible that both win: supposing the option an at-the-money call, if the underlying increases in value then the client wins; but if it increases in value slowly, i.e. doesn't gyrate more than the implicit level of volatility of the option which was sold, then the IB wins as well.
Also a lot of the deals come from regulatory and tax arbitrage. The client trades with an IB because the IB's product gives it an advantage over a regulation or a tax. In the case of tax arbitrage the loser is the concerned government; the client and the IB split the tax saved.
P.S. Daryl, I have heard of Goldman Sucks but not Goldman Sacks.
Polemical reasons is your only understanding of Finance anyway
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 11:34 AM PST.
Much of the Swaps trade is between financial houses, so you're without a good empty-minded populist target there.
Of course, much derivatives usage is by large corporates hedging risk, and which - because they are not illiterates - look at the derivatives payments like insurance payments (which they are in effect). Insofar as large corporates are also not in your Left-Populist matrix of Good Actors, again not much of a target.
It is, in the end fundamentally illiterate and stupid to look at insurance payments as losses, although typical of your writing on these issues.
The Lounsbury: "Much of the
Submitted by alex (not verified) on Thu Nov. 5, 2009 12:07 PM PST.
The Lounsbury: "Much of the Swaps trade is between financial houses, so you're without a good empty-minded populist target there."
Good point. It's all private enterprise, so the taxpayers won't get stuck holding the bag even if the other party looses out (*cough* AIG *cough*), right?
My note had nothing to do with your point
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 12:26 PM PST.
As usual, your sub-literate reading skills have led you astray. I was not commenting with respect to any risk management implications (although your "cough" is misplaced as interest rate swaps are an old and well-known product, only the crazy things AIG's unregulated offshore unit engaged in); only on Drum's misplaced search for populist polemics.
Of course interest rate swaps are subject to regulation, which would be the vague point you were grasping at.
You really need to become a
Submitted by alex (not verified) on Thu Nov. 5, 2009 1:09 PM PST.
You really need to become a more creative apologist. No shit there's a difference between an interest rate swap and a CDS. If you have any actual useful information to convey about financial details, which on rare occasion you have, then please do so. However, your forest for the trees approach to attempts to debunk complaints about our honest, hard-working and productive finance industry has gotten pretty tired.
Your approach is analogous to someone complaining about their car dying at 30k miles because the big end bearings were defective. No, you stupid git (or is it wanker?) the journals weren't properly polished, the bearings were just fine. Oh, then it's all ok and they've nothing to complain about.
The Lounsbury: "interest rate swaps are subject to regulation"
Thank goodness for that - we all know how effective US financial regulation is!
Whinging on about too sunny, too rainy...
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 2:47 PM PST.
I rather consistently give you information, although you in particular are too dim to understand it, or as well to wrapped up in your devotion to bitching about your porridge not being just right.
US financial regulation is fine in some areas, others not; indeed I have pointed out for you what areas are piss poor, and why. Swaps have not been problematic, and are quite well-established (decades well established) instruments.
Your approach is to whinge on about everything, insofar as it is self evident you're caught up in irrational populist rage against finance as such. Which is pointless. Wailing about bank failures, but then wailing about too much profit. ... Sad whankers.
The Lounsbury: "Wailing
Submitted by alex (not verified) on Thu Nov. 5, 2009 3:54 PM PST.
The Lounsbury: "Wailing about bank failures, but then wailing about too much profit"
Love your binary thinking.
I'm happy when the recipient of taxpayer charity doesn't wind up starving in the street. But when he is found staying at the Plaza and dining at Per Se, I may be forgiven for wondering if it isn't time to cut off the welfare checks.
Otherwise, on the interest rate swaps
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 11:41 AM PST.
Actual usage is generally in a scenario such as you can get a lower floating rate, but desire to lock in a specific rate over the term. One enters into a swap, with the fee to a Goldie, which of course is more expensive than not, but you no longer worry about the floating rate and one still ends up with a cheaper price than the fixed available to you for that term (unless you're an innumerate idiot of course). So a Goldie soaks up the rate risk, and books profits so long as the rate move is not crazy.
In properly arranged hedges, it is not a zero sum for the Economic Transaction, only if one looks at a derivative in isolation of the economic value of whatever the hedge was.
Your analysis is about the same level of intelligence as people who don't but insurance against fire risk 'cause fire never happened to them, and its a "waste" or a "loss."
It's not just the big boys.
Submitted by eb (not verified) on Thu Nov. 5, 2009 12:17 PM PST.
It's not just the big boys. Take, for example, a homeowner who failed to anticipate that the Fed's largess to the banks could continue for this long, and re-financed from a LIBOR-based variable-rate mortgage to a fixed at what seemed like a nice 5% rate. She's paying north of 1% in excess as a result, and whoever's holding the fixed paper is laughing all the way to the bank.
Of course, it probably is a bank.
There are no doubt many similar examples.
Both Kevin and Felix missed
Submitted by alex (not verified) on Thu Nov. 5, 2009 12:27 PM PST.
Both Kevin and Felix missed the real story, even though it's the point the WSJ article that Felix links to:
"The Wall Street firm's filing on Wednesday contained an eye-popping number: The interest rate on its long-term borrowings was a minuscule 0.92% in the third quarter, down from 3.53% in the third quarter of 2008."
Woo-hoo, interest rates less than 1%! Thank goodness for "free enterprise". Can I get that for my mortgage?
Of course with the economy doing so well now would be an inappropriate time to mention Golden Sacks' curious new status as a bank holding company (even more recently a financial holding company, but it's little different). That's a status that's only supposed to apply to depository banks (which GS ain't) and that gives them privileges like FDIC guarantees and access to the Fed facilities (many of the new ones secret thanks to the FRB's refusal to tell us what they're doing with the Federal government's Constitutionally granted power to regulate the value of money, and congress' well bribed refusal to force them to). Of course the holding company status is supposed to come with all sorts of reporting and regulatory requirements, but GS hasn't even made a show of complying.
If you can borrow long term at 0.92%, how can you not make money? GS's real genius was in buying the US government - what an investment!
Refinancing a mortgage at a fixed rate is not a swap transaction
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 12:29 PM PST.
Your example is bollocks.
A swap transaction does not involve changing the rate on the underlying credit.
I am not familiar with the details of American rules on derivatives transactions, but I rather doubt they are available to ordinary consumers due to the complexity.
Thank you for making yet
Submitted by alex (not verified) on Thu Nov. 5, 2009 1:34 PM PST.
Thank you for making yet another distinction without a difference that's pertinent to the discussion. I'm sure eb knows that the mechanics are different, but your affectation of obtuseness leads you to ignore that the effect is largely similar.
The Lounsbury: "I am not familiar with the details of American rules on derivatives transactions, but I rather doubt they are available to ordinary consumers due to the complexity."
Ah, the fabled complexity. Of course in many cases the complexity is a feature. Like the complexity of three card monte - now you see the scam and now you don't! Spare me the drivel about how certain derivatives serve a useful function. Of course they do. Nevertheless my point about complexity stands. The latest use: congress' proposed window dressing regulation of derivatives excludes "custom" (read purposely over-complicated) derivatives. How convenient.
Your aggressive ignorance is well noted
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 2:37 PM PST.
However, a refinancing that results in a new, fixed rate on a new credit is a fundamentally different operation than an interest rate swap.
It is hardly a "distinction without a difference," moron.
Refinancing results in a credit on the banking book, which is provisioned as a credit, has entirely different legal claims, and might go into a securitised portfolio. The borrower, unlike in a swap, has no ongoing counter-party risk, in a derivatives transaction there is ongoing counter-party risk, even though typically in organised markets these are marked to market on a daily basis.
The ongoing counter-party risk is not only a risk to the swap party(ies), in a large aggregate this presents a potential system risk.
In short, my dear drooling idiot, its FUCKING FUNDAMENTALLY DIFFERENT in all the ways that you, if you had some basic numerate skills, would be rightly worried about.
But no, you prefer to wail and gnash your teeth in blithe ignorance. Woe is the world because finance exists...
Pointless and without any real effect.
Thank you for proving my
Submitted by alex (not verified) on Thu Nov. 5, 2009 3:36 PM PST.
Thank you for proving my point.
The Lounsbury: "It is hardly a 'distinction without a difference'"
Much trouble reading the fine print Loon? What I wrote was "distinction without a difference that's pertinent to the discussion". So in attempting to distract from the key point with your rant about the financial and legal distinctions, you ignored the fact that inside information and influence is awfully helpful in deciding whether to go with a fixed or floating interest rate.
The Lounsbury: "Woe is the world because finance exists..."
Talk about missing the point. It's precisely because finance is an essential overhead function in a modern economy that people are so upset about its rampant corruption and exorbitant skim.
Further, interest rate swaps
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 3:07 PM PST.
in most markets are in fact a model of the proper use of derivatives, including being passed through regulated exchanges which require the proper posting of collateral, netted on a regular basis to manage the risk of failure.
So again, your knee jerk complaining and ignorant conspiracy mongering leads you astray, you stupid leftist git. One should be bloody happy if profits are being made in effectively plain vanilla markets instruments passing through organised, regulated exchanges. That is what you fucking fools were screaming for months back.
And it is even more fucking senseless and drooling hypocritical to be whinging on about banks making profits off of the spreads, because THAT WAS ALWAYS WHAT WAS SUPPOSED TO BLOODY HAPPEN, you dumb sad git. From the very bloody start, that is the baseline policy and the way banks recover in financial crises, it's the bloody point of the policy.
You idiots simply knee jerk and cry and pull out your hair about any bit of little financial news out of sheer drooling ignorance.
Bloody well complain about the unreformed regulatory network in the US or the opposition to the consumer regulatory oversight (and the massive carve out for one type of banking license, a bloody future catastrophe in the making) or the apparent lack of thinking about addressing the Securities Rating Conondrum (the Moodys-S&P duopoly). Those things make sense.
The Lounsbury: "interest
Submitted by alex (not verified) on Thu Nov. 5, 2009 4:20 PM PST.
The Lounsbury: "interest rate swaps in most markets are in fact a model of the proper use of derivatives, including being passed through regulated exchanges"
Here in the US a lot of swaps are OTC.
The Lounsbury: "And it is even more fucking senseless and drooling hypocritical to be whinging on about banks making profits off of the spreads, because THAT WAS ALWAYS WHAT WAS SUPPOSED TO BLOODY HAPPEN"
It's the very fact that it was supposed to BLOODY HAPPEN that we're complaining about. Arguably a valid use of a policy of excessive spreads is to re-capitalize banks. But when they have large profits and are back to exorbitant compensation it's time to cut back on the handouts.
The Lounsbury: "the way banks recover in financial crises"
Is to enrich the very people who caused the problem? A variant approach is receivership which is not only permitted but mandated by US law (not that anyone pays attention to silly little statutes when they're allegedly TBTF). Then even if spreads help to re-capitalize, at least it removes the moral hazard of enriching the very people who screwed up in the first place, and the foolish investors in such institutions.
Oh well, no secret that personal responsibility and staying off welfare are but a tongue-in-cheek morality tale fed to peons, not the Financial Masters of the Universe.
The Lounsbury: "Bloody well complain about the unreformed regulatory network in the US or the opposition to the consumer regulatory oversight (and the massive carve out for one type of banking license, a bloody future catastrophe in the making) or the apparent lack of thinking about addressing the Securities Rating Conondrum (the Moodys-S&P duopoly)."
We frequently do. Corruption leads to oh so many abuses.
And as to complexity
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 3:19 PM PST.
Interest rate swaps are not exotic instruments. Anyone with basic finance skills should be able to use them.
However, the average consumer has a hard time with basic maths, never mind basic finance. The complexity is relative, and there is certainly no enough benefit to your ordinary individual consumer to engage in derivatives transactions (unless they want to go learn the derivatives maths and spend lots of time monitoring). There's no bloody 3 card monte my dear Leftist ignoramus, it's very straight-forward.
Worth it for a medium sized enterprise, either in the real sector or otherwise, but a ridiculous overkill and bother for an individual.
So do try to control your habitual bed wetting and wailing.
The Lounsbury: "Interest
Submitted by alex (not verified) on Thu Nov. 5, 2009 3:59 PM PST.
The Lounsbury: "Interest rate swaps are not exotic instruments."
I have no end of faith in our Financial Genyuses to make them just as complicated as need be to evade congress' latest sham regulation proposal.
"Anyone with basic finance
Submitted by The real a (not verified) on Thu Nov. 5, 2009 10:13 PM PST.
"Anyone with basic finance skills should be able to use them."
No. Look at Jefferson County. Hello, look at Larry Summer at Harvard, who didn't understand that a swap wasn't appropriate.
Jim Cramer yells a lot
Submitted by tpx on Thu Nov. 5, 2009 1:25 PM PST.
Why are finance capitalists so abusive? Abusive bluster is a first line of defense from being discovered as a fraud, or worse. People who add no value to any goods or services, yet are compensated very well, have to be abusive to deflect the curious from too carefully examining what it is they do. Like con men, and neocons, they reflexively abuse anyone who questions or criticizes what it is they do, or want to do, because they cannot provide legitimate reasons for it. Attempting discourse with finance capitalists immediately leads to ad hominem attacks because they can make no rational arguments about the value of their work. Pressing them turns them into abusive interlocutors because they have no logical rebuttals to make when confronted with the lack of value or the fraud or the corruption or risk to the innocent their activities create. When the markets crash from their activities, they escalate their abuse in order to protect themselves and to protect the system that provides them so much wealth, which is another reason why it is so difficult to regulate the finance industry.
Totally different. But not necessarily disconnected.
Submitted by eb (not verified) on Thu Nov. 5, 2009 2:20 PM PST.
The Lounsbury - yes, the mortgage refi I described is not remotely a leveraged swap transaction. It was only intended to be an example of who's on the losing side of the recent bout of financial engineering, which I thought was Kevin's larger question.
The point was that the bigger leveraged players might have mitigated their losses at the expense of the many who, like the aforementioned home-owner, were less well equipped to influence, I mean, anticipate, Fed actions.
That's hardly the same sense at all
Submitted by The Lounsbury (not verified) on Thu Nov. 5, 2009 2:42 PM PST.
A homeowner should not be trying to squeeze out the last bit of financial leverage out of a home. That sort of play and thinking is precisely what got American into the spot it is in. A homeowner has not the time or reason to spend valuable hours (which might more profitably be devoted to family or home improvements, or whatnot) tracking central bank interest rates.
There is no "loss" to someone who refinanced and perhaps missed a tiny bit of spread, except in some pointless financial over-engineering of houses.
If homeowners can refinance to an affordable, stable fixed rate, and then concentrate on life, that is good. The banks exist to obsess about spreads, human beings outside of banks are not well-served by pointless over-optimisation - I find it equally sick to see Americans whinging on about trivial moves in credit scores and otherwise obsessing about transient nonsense.
The Lounsbury: "A homeowner
Submitted by alex (not verified) on Thu Nov. 5, 2009 4:37 PM PST.
The Lounsbury: "A homeowner should not be trying to squeeze out the last bit of financial leverage out of a home."
Re-financing at a lower rate isn't about "trying to squeeze out the last bit of financial leverage out of a home." I can well afford my conservative mortgage, but wouldn't complain about the extra money in my pocket if I could re-fi at a 1% rate. Maybe then I could dine at Per Se too.
The Lounsbury: "That sort of play and thinking is precisely what got American into the spot it is in."
That and the banks that sold trash as AAA.
The Lounsbury: "If homeowners can refinance to an affordable, stable fixed rate, and then concentrate on life, that is good. The banks exist to obsess about spreads ..."
Shorter Loon: as long as you're not defaulting, don't worry your pretty little heads about interest rates. Those are for bankers to make money on (as assisted by their wholly owned subsidiary the US government).
The Lounsbury: "I find it equally sick to see Americans whinging on about trivial moves in credit scores"
We'll stop obsessing about credit scores when banks and other companies stop using them to determine how much things cost us.
The Losers
Submitted by RobertWaldmann on Thu Nov. 5, 2009 4:39 PM PST.
One is born every minute. Some bets are always wrong. 100% of the time.
Goldman Sachs and Wells Fargo bet against investors who predicted that long term interest rates were going up. There are almost always certified experts who predict much higher long term interest rates than most experts. They think the US is about to start an inflationary spiral *and* that everyone else will recognise it soon.
They are always wrong. Always. This is a demonstrated claim about Blue Chip TM forecasters. In that sentence, Blue Chip is an aggregator not a slang term.
When I say always, I mean always, without any exception ever. The evidence is here
"who’s on the other side
Submitted by JS (not verified) on Thu Nov. 5, 2009 11:27 PM PST.
"who’s on the other side of the trade? Who lost billions of dollars by swapping floating into fixed?"
What a strange question from Felix Salmon, repeated by Kevin. As I understand it, what Goldman did was the equivalent of getting a fixed mortgage, then refinancing at a variable rate (betting the rates will go down). They were right, and the rates did go down. So their debt cost went down. What's wrong with that? Are we now going to blame someone for betting the rates will go down and being right? This seems silly to me.
As to who lost those billions that Goldman saved: Suppose Alex was able to refinance his mortgage at the 1% rate, as he says he would like to do. Should we be looking for his victim? Is someone losing the money he is saving from his monthly payments and spending at Per Se?
The notion that rate swaps (which I don't believe can be called derivatives) as well as derivatives in general are zero-sum is, I think, wrong. With stock options, the simplest derivatives that are available to everyone, there are many scenarios in which both buyer and seller make a profit. A covered call, for example, if the underlying stock goes up significantly. (And both sides lose money if the stock goes down significantly -- unless they hedge with other positions).
Delaware beats Switzerland
Submitted by Josh Fulton (not verified) on Sat Nov. 7, 2009 9:32 AM PST.
Delaware beats Switzerland as most secretive financial center
http://joshfulton.blogspot.com/2009/11/delaware-beats-switzerland-as-mos...
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