What is the Greater Good

As a firm believer in the idea of the European Union (EU) despite the many problems associated with it I am especially at a loss regarding the negotiations with the Greeks.

First, as a bit of background, I support the idea of a Federal Europe which goes far beyond the current construct.  A monetary union without a fiscal union, which by definition presumes a political union was always going to be a problem.  But sometimes the perfect is the enemy of the good.

Believers in Europe amongst the political elite felt that a trade and monetary union, even without a fiscal union was better than no union at all.

And until the Great Recession it was.  Prosperity was the coating which glossed over many of the problems inherent in the structure.

Even after the crisis and despite the harsh austerity budgets forced upon the Irish, the Portuguese, the Spanish, the Italians, the Balts, the Slovaks and even to a degree the French,  the monetary union held together.

Greece on the other hand, despite a loan of Euro 110 billion and a write-off of 50% of the outstanding debts owed to private investors has resisted the austerity measures forced upon it as part of the new loans it requires to stave of insolvency.  It has elected a government which happily accepted the poisoned chalice of a dual mandate  renegotiating the terms of the loan and keeping Greece in the Euro.

That's what populism gets you.

So I ask myself what is it about Greece that makes them unwilling to accept the austerity terms that the other nations begrudgingly accepted.

Greece has a difficult history.  It was part of the Ottoman Empire for over 400 years gaining independence in the 1830's.  Since then it has gone from a republic to a monarchy to a republic to German occupation to a civil war to a republic to a military dictatorship to a republic.

Greece joined the European Union in 1980 and joined the Euro in 2002.  As with many countries involved in the Euro there was a bit of statistical magic to get the Greeks to adhere to the Maastricht Treaty requirements.

Many observers are quick to point out that the Germans manipulated their statistics to reach the 3% of GDP debt level so why should one query Greece's accounting tricks.

That might be where the problem began.

Germany was in the midst of trying to incorporate the former East Germany which unsurprisingly was a very expensive undertaking for which the Germans are still paying through the solidarity surcharge.

But Germany has an economy.

Even before the Great Recession Greece was behind the rest of Europe.  In 2008 only one third of households had internet- less than anyone else in Europe including the Baltics and some south-east European nations.  Youth unemployment and government debt were among the continent's highest despite major funding through the EU's infrastructure development program.

Since then unemployment has tripled to 26% with over three quarters of the jobless being out of work for 12 months or more.  This has happened parallel to a serious decrease in the birthrate coupled with mass migration of youth seeking opportunity (youth unemployment is over 60%).  This has left Greece with an ageing population dependent upon state pensions.  Over one third of the population is on the cusp of the poverty line, more than any other euro-zone member.

And yet everything you hear from the Greeks is that it's someone else's problem.

Today,Greek premier Alexis Tsipras has accused the EU of intentionally trying to subvert the Greek democratic system, having pillaged the country for the last 5 years and now trying to institute regime change.

I have been against a Grexit.  I still would like to avoid it.  But as the adage goes, "as long as my neighbour wants to fight I will have no peace".

Mr Tsipras seems to think this is a game and that at the end of it everything will be fine.

He is totally wrong.  And his arrogance could certainly bring the Great Depression to Greece.  With that comes financial and political chaos.

This is about to get very ugly.
   

Suddenly the Billionaires Care About the 99%

I have just read two articles, one by Mr Stephen Schwarzman, CEO and co-Founder of Blackstone in the Wall Street Journal (WSJ) and the other on Mr Jamie Dimon, CEO of JP Morgan in CNN Money. They are both members of the billionaires club thanks in a large part to the excesses associated with Quantitative Easing  (QE)which created ferocious bull markets predicated on essentially free money.

Now they both have suddenly got religion and are out explaining how the the Dodd-Frank Financial Regulations are the harbingers of the next financial crisis and how this will hurt the mom and pops of the world.

The culprit: a liquidity crisis which Mr Schwarzman attributes to the prohibition on proprietary trading by the banks.  He explained that this prohibition, when combined with enhanced capital and liquidity requirements has led banks to avoid some market-making functions in some key equity and debt markets.

Really?

In the same article Mr Schwarzman tells us that Deutsche Bank noted that dealer inventories of corporate bonds are down 90% since 2001.  And this despite the outstanding supply of corporate bonds almost doubling.  Funny that.  I could have sworn that the Great Recession started in 2007.
And the doubling of outstanding corporate bonds has been driven by QE which was inaugurated in 2008....

Mr Dimon on the other hand, whose bank is one of the largest issuers of corporate bonds was quoted, along with a 'slew' of other smart people on Wall Street that there is a liquidity crisis looming and "...in a crisis there might not be enough bonds to go around".

So which is it.  Is there going to be a liquidity crisis because there won't be enough bonds around?  Or is the prohibition on proprietary trading, which is run solely for the banks profit, stopping those same banks from fulfilling their role as financial intermediaries and helping facilitate a fair and orderly market- and thus contributing to a liquidity crisis?

I'm not sure that either of them know.  But the cake goes to Mr Schwarzman.  His concern for small business owners, farmers and local real estate markets is predicated on the fact that the traditional lender to this segment of the economy are the Community Banks.  Their number has decreased 41% since 2008, and he blames this on Dodd-Frank.

Selective memory perhaps?

The major cause of the demise of the Community Banking sector was that they all held the preferred stock of the housing related government-sponsored enterprises (GSE's)-Fannie Mae and Freddie Mac which went into conservatorship before Dodd-Frank.

Banks were able to hold considerable amounts GSE preferred shares because, even though banks are normally restricted from investing substantially in equity securities, an exemption to the standard limits on permissible equity securities was established for the GSE investments.

Some will cry that Mr Frank and Congress were behind this, trying to expand home ownership in the United States.

Other more sanguine observers will remember that the reason the real estate related GSE's went bankrupt was that the major banks and unregulated private lenders stuffed them with sub-prime loans rife with major documentation problems.

The truth is that all of these highly respected billionaires have been against financial regulations from the start.  Wall Street smells blood and is starting to flex their muscles in the political corridors of power to try and roll back history.

They have learned though. This time they are cloaking their desires in the guise of wanting to protect the little guys- and reopen the floodgates to unregulated financial markets.

The Music Stops at Deutsche Bank

The recent resignations by the Co-CEO's of Deutsche Bank, Juergen Fitschen and Anshu Jain have come as a bit of a surprise to many.

To me it was just a matter of time before the music of the investment banking merry-go-round that was Deutsche Bank would stop and there would be far too few chairs for everyone to find a seat.  

Mr Jain, an excellent salesman who honed his skills in the 90's forging excellent relationships with the hedge fund community was one of the first people Mr Mitchell took with him when he left Merrill to join Deutsche in 1995.  

The Deutsche Bank they joined was essentially a large commercial bank with a poor investment banking franchise outside of Germany where it was big player in a small pond. The Merrill Lynch Mr Mitchell joined in the mid 80's had been a similar animal.  A player with the slow accounts, and pretty much not involved with fast money.  It was known as a wire house which essentially traded in between the institutional and the retail market.  

Upon joining Deutsche Bank they set about turning it from a "broker" into one of the premier principal houses on the street.  At Merrill everyone wanted to be Goldman Sachs, but the retail broker mentality of the senior management never understood risk and so were always uncomfortable with it.

The cultural gap between a Deutsche Bank, or a Merrill and a Goldman was that the former were big and ponderous and the latter was smart. very smart, and utterly ruthless. In addition to this despite the fact that it had gone public, which in and of itself was a reflection of their smarts and their ruthlessness, the partnership culture hadn't been defaced.

Deutsche didn't necessarily yearn to be a Goldman Sachs, but they were certainly not happy to be a big fish in the (relatively) little pond of Germany.  Under Mitchell and Jain the way forward would be to work with the fast money, essentially becoming one of them, willing to take serious principal risk and looking for the slow money, institutional or retail to help take them out. 

And although Mitchell and Jain were certainly smart enough and definitely ruthless enough to work at Goldman, Deutsche offered the best of both worlds.  They could replicate Goldman's culture, but unlike Goldman, use OPM- other people's money.  

And those other people were the shareholders, large and small, representing one of the bastions of the German financial, social and political establishment. 

Moving over to Mr Fitschen for a moment, he was part of that German establishment.  That is not necessarily a compliment.  Without going into a longwinded history of Germany there are still remnants of what Prof. George Stein described as "feudal modernity" in Germany, especially in such institutions such as Deutsche Bank.

Meritocracy is not a hallmark of such institutions.  Many would say that the only reason Mr Fitschen was elevated to Co-CEO  was that he was a Deutsche Bank insider. Mr Ackermann who picked up where Mr Mitchell left off* with the added benefit that he could speak German could fit into the Deutsche Bank hierarchy.  Anshu Jain could not.  

The Co-Head solution is the worst solution an institution can impose.  The suggestion that the world could be split into a domestic and non-domestic market was a throwback to pre-Mitchell days.  

And so, regardless, the co-head structure meant that as long as Mr Jain could deliver profits, his star would stay aloft. 

But his profits stagnated, and his organisation began to find itself embroiled in regulatory/legal disputes which took much management time and in the end would require far-reaching changes in the way the Bank operated.  

Enter Mr John Cryan.

A Brit, who speaks German.  A finance guy which is bankspeak for someone who not only looks at the revenue side of the balance sheet, but also the cost side.  

Under Mitchell Deutsche Banks cost ratio was continually bumping up against 98-99%.  My motto was that one wanted to work at Deutsche Bank, but not own the stock.  This continued under Ackermann and as recently as the end of 2014 it was still over 75%. 

Most investment banks target a cost income ratio below 65% and in really good years are in the 55% range.  Those with high cost income ratios tend to focus on revenues, or more specifically revenue growth.  Those with lower ratios look very closely at costs.

I should expect that Mr Cryan will swing a sharp blade cutting into much of the fat at Deutsche Bank.  He will certainly cut into muscle.  The question is will he cut into the bone.
Cost ratios are important.  As are capital ratios.  Human capital is probably the most expensive, and so it is where Mr Cryan will focus, followed by capital usage.  

The question is whether the accountant Mr Cryan will be able to square the circle of cost cutting while maintaining the revenues.

I understand he left UBS because he found the stress of the turnaround overwhelming.  

Herzlich willkommen nach Deutschland.....

*Mr Mitchell died in a private plane crash December 2000.

Private Violence

I just read a review on the nature of States and how they have changed over the last 500 years.  The premise is that we have evolved from the Princely State of 1500 through to the Kingly State; the Territorial State; the State Nation followed by the Nation State and that we are now entering the time of the Market State.

The article described the various State types and the causes/stimuli for their evolution over the last 500 years.  Although there were many interesting points I was struck by two specifically.

The first is that the constitutional order of a state and its strategic posture towards other states form an inner and outer membrane of a state.

So far so good. It wents on to explain that these membranes of States are secured by violence, without which a State cannot exist, and that the violence a State deploys must be viewed as legitimate.

Now throughout history there have been innumerable cases of the private sector exercising violence on behalf of the state.  I think of the privateers Sir Francis Drake and Sir Walter Raleigh as perfect examples of how the State allowed the private sector to further its goals through the use of violence.
 
This is not to say that the private sector wasn't involved previously, nor that it has been dormant since Elizabeth I.

The military-industrial complex Eisenhower warned against didn't occur overnight.  Weapons, ammunition, vehicles etc have been supplied by the private sector for centuries.

But the assumption of many activities by the private sector, be it a Burger King on Haliburton built army bases in Afghanistan, Iraq or even in the USA to the hardly discernible division between "Security Services" and mercenaries not only reflects the old adage that War is Good Business, but also portends to a more sinister transition.

For if we are indeed morphing into the next state of Statehood, and that is indeed the Market State,
do we now have the private sector determining the use of violence, externally as well as domestically?

The Transatlantic Trade and Investment Partnership (TTIP) hints at the first step of removing legal responsibility from the State to the private sector.  Rather than turning to the legal system to solve disputes TTIP will bring in "corporate courts" which will follow guidance written by corporations for corporations.

These courts will be controlled by arbitrators who oversee proceedings undertaken in a closed "court" focusing on questions of free trade and (quite probably) disregarding issues such as public health, environmental protection, employment rights and other social rights in favour of maximizing profits.

Nothing wrong with maximizing profits.

But something very wrong with corporate kangaroo courts.  And those "courts" will be the basis for Investor-State Dispute Settlements (ISDS) which allow un-elected transnational corporations to sue governments if the policies of those governments cause a loss of profit.

This is already happening to an extent for example in Germany Vattenfall, a Swedish company operating nuclear facilities in Germany is suing Germany for its decision to exit from nuclear energy in favour of renewable energy.  But it is being discussed within the confines of the German Constitutional Court.  Not a private ISDS forum.

This sort of snowballs into my second point.

Privatization has been the battle cry of the Chicago School of Economics.  Free Marketeers are the modern version of privateers.  Market decisions are always right, and although initially the neo-classical economists were content to confine government to the 18th century functions of justice, police and arms I am unclear as we move into the Market State what role government will have in this new Jerusalem.

For without government what legitimizes the use of violence....and without violence there is no state.