Here is a rough transcription of the presentation for people who are hard of hearing. Apologies for the lack of grammar, I am working to improve the automated transcriptions -
Theo my Sunday this chart up is from Deutsche bank and it is the five-year total return performance of major global financial assets things you can bet on over the last five years and how they done up season downs ease why five years now because it kind of the financial Times is decided that is the five-year anniversary of the credit crunch now I putted a bit earlier when the around their standard stones hedge funds is ran into trouble but financial Times being more European-based they go from the BNP Paribas money market funds closing arm which was obviously in August so five years on from then if you’d invested on that day five years later what asset class has done the best dust so the sticky ones are obviously the goodies and the sticky down ones are the baddies so let’s have a quick look at corn is number one just above gold at call I imagine because it’s taken a late surge with the power drought in the United States so I think it come along and Don will rush right at the end to be gold over the five-year period silver comes in next Brent is next that Brent ordeal crude oil as representing the oil market the arm price of a barrel I would not next US IG non-Finn that’s United States are IgE is investment-grade non-financial bonds so it looks like the light blue that’s look over your gilts next gilts are UK Treasury’s acting grey sticking up US corporation sticks up there in my blue sunlight blue are bonds are issued by companies sticky upgrade are bonds issued by countries the dark blues are commodities stickier red FTSE but Vespa and S&P sticky the Reds are equities and his blacks there which is money you can make on the forex market or at least of these five years money that you’re going to lose on the forex market could they stick downwards and over towards the end all those red sticking down are all stock markets are all equities so curling gold silver oil commodities win and then it’s now fixed income securities bonds you buy a bond for a fixed income are fixed interest rate securities and surprisingly the FTSE is the best performing stock market right down there towards the skinny bit corny outcome okay and I don’t know that’ll probably be our idyllic call even got a spot price I think the deal so much in the futures market that am but I imagine it’s if he has a spot price it spot price to spot price but talking of futures okay futures lots of Chicago are commodities exchange deal in futures they deliver lots of things but that was their speciality in the beginning that harm future is a derivative is a derivative of the actual are stock law or the actual are in this case: it’s the actual asked after being taken in from the feels the physical material at the a future is a piece of paper and which is a pet most all of derivatives are bet it’s a bet on the price of that particular unit in this case corn at a future is basically the farmer says what I know when the crop comes in in six months I want this sort of price I want this price and the something along comes along who knows better who knows that Russia is going to get wiped out with bad weather and the price of this chaps corn in the United States is going to go up he only wants this much so he says I’ll definitely buy that few and the bet is that Russia gets bad weather the price of corn goes up and are when he buys it at that low price which will be the spot price in six months time which will be elevated you be able to guarantee a win but they’re the clever fella that put the buys the future off the farm now all this goes through the exchange which is the Chicago commodities exchange and the dealers there that deal with all the paperwork is work so that’s a future you buy you you agree to buy something at a certain price in the future and option and option is another derivative and obviously needs the none of these are just great because they’re been going so long that they have is grey areas all round them but these are basically what they wear ourselves hugely guaranteed to buy something in certain price and option is that you pay a certain amount of money say per month for those six months and as you keep paying that and that guarantees you an option to buy say at farmers 50 the farmer wants 50 the clever fella is says I’ll definitely buy that for you 15 six months because he’s betting it’ll be 70 right so that’s the future and option is you say well I’ll pay you a certain amount and this will be done through the exchange a certain amount each month October dates to give me the option to buy at 50 and if Palm when the time arise it right and it’s gone to 70 or a number that I thinks elevated enough I shall exercise that option and by that few but I’ve got the option not to buy it off you and you’ve got the payments that I paid up to then one single payment it’s more likely to be up to then you’ve got that in recompense for me not buying it you still got your corn if that’s what it is and you’ve got the the fee that I’ve paid you for the option to buy it okay so that’s am options futures options listed House of Commons modesty markets and go to swap swaps swaps in disruptions now as well boy were going to them swap now the first the swaps surprisingly fun millions of different things can’t think of a commodity is one of the top head that it be easy like the first one the first swap or first big big swap was harm and not forget who brokered it but I’m pretty sure is IBM and one of the fancy World Bank or your World Bank and the World Bank now each of those two IBM and the World Bank could wanted to raise money wanted to raise money in bonds but the World Bank normally raised in bonds in Swiss francs IBM raised their bonds in dollars but at that particular time I IBM wanted Swiss francs and the World Bank wanted dollars or something like that anyway it came to pass back in those days it would be the 80s exposed that the was a broker that said well look you to together you do your individual bond raises and then just swap the and cash flow from them you want the dollars you want the arm you you you want the Swiss francs to swap them and that was arranged as a swap this and then since then it just so many things you think well as to walk with why would you ever want to do that but there are so many reasons that one out thick can do one thing in one way and another outfit concludes things in another way and it is convenient for them just to swap they the most important thing is they hold whatever it is that’s the derivative of the main contracts on their own books or more on the banks books but then threw the broker they organised to swap something over like it might be harmed mortgages say somebody has got a fixed mortgage and summaries, floating rate mortgage they leave the mortgages where they where are but the broker agrees that and you want the floating rate when you got fixed you want fixed when you got floating rate so will agree we sign a contract are lawyers coming then go away and from now on you leave the arm mortgages where they are but the you will pay a fixed when that’s what you want new play the floating that what you want although the mortgage doesn’t change on on the actual banks books And eating well there’s not many of those sort of things that could be arranged the world is awash with people who want to swap things over here it’s really quite amazing and those little things and they get these little ones and they can get and bundles of little ones knowing that some the arts were got a bundle of another lots of little ones they swap the bundles over its it going you think by how when you pay the lawyers Fianna bankers they can ever work out they seem to make it work out as a swaps options for its main derivatives main derivatives credit derivatives credit default swaps soul let it go again to the first big credit default swap because arm noted vaccine securities and all that sort of thing really come under the heading of credit default swaps the first one was the JBM and Blythe Masters brokered deal between the bank for overseas development and Exxon it was made in 90s Exxon had the Exxon Valdez disaster they needed lots of cash they needed no overdraft loan from JP Morgan who were there bankers but here we run into Basel one all bile Basel one regulations the had the certain capital regulations that you should have and it was going to be a big loan $5 billion and in 1990 990s anyway it was 5 billion was 5 billion back then which would put it would be alone it be fired on the asset side five on the liability side Either Nick or harmful while fives but you’ve got capital requirements which are normally a percentage of equity against your asset side down the asset side of equity let’s go equity is really even more that the asset side is more than the liability side that’s what’s left over is equity that what technically the owners of the company own the difference when the banks profitable and then that could be tried violence and tried to be cut up and given to the owners but in its whatever is so the equity which is assets over liabilities wasn’t going to grow because God be 55 deal bites arm the asset side I am not too good numerator is in denominators anyway it was good that that loan was good to put their capital position in a out up to the limits or over the limits let’s say Basel one agreements for capital reserves but they couldn’t deny Exxon because Exxon is obviously good customer and so the deal obviously went through when they got their overdraft Exxon got their overdraft the Blythe Masters who was arm in derivatives department: derivatives department and this was the start of the idea of credit default swaps out what she did and where did she go she went your to the bank of overseas development again I was in Switzerland I think they are and I got lots of cash as to know what to do do with and they even like all banking types they want to make safe investments so what Blythe Masters said was look we got we will like almost all of these deals go we’ll leave the Exxon: books but we want to sell off the risk for this completely so who will buy the risk so she goes over and organises the arm Bankfoot over seas investment when it was only then they still work and European bank for overseas development yet to what you could call by their risk off them but what it really entailed was a contract being signed between the two of them that JP Morgan pays be EO p D a certain fee per year and that would be considered interest for the heart overseas development bank and just a payment thick payment to stream and what the agreement was that they would accept that stream but if Exxon defaulted would take the default on their bar backs But knowing that Exxon is not going to default at all and it was just free money they were just being paid for nothing but that got the actual risk off JP Morgan’s books okay and interesting thing here is to say what what difference does that make to the Basel one because it capital requirement and JP Morgan were in the slightly and different our position back in the 90s because they were the good bankers they relied an awful lot that they had because they will go back to JJ people Pierpont like Pierpoint Morgan and Jack Morgan is some very liked their big corporate clients and to have a relationship with them and it still existed in the 90s but it was about to change when the derivatives outfit in JP Morgan started making all the money basically and the old and the old way of doing things just wasn’t making the money so eventually the derivatives players were all promoted above them and the whole ethos of the bank changed but they like their corporate clients so they they would always keep they wanted to keep the couldn’t sell the entire loan they wanted to the one-to-one thing that would be Exxon the would be an Exxon man that would deal with the JP Morgan man who would be their banker so JP Morgan had to say no keeping the harm the loan on our books and probably wouldn’t even bother telling them that then that sold the actual risk of it off anyway so Basel how this wasn’t actually going to affect Basel but obviously it was an advantage so that the JBM people went to the Fed and said look now would solve the risk of something like this do we still have to arm do we still have two hold the same 8% it was for Basel 18% of our capital and the Fed said were well let’s think about it and then said no one will we don’t think you should but were not totally happy with this could we don’t really understand and a couple years went by and there were mad years of the more of these derivatives going out and goes JP Morgan thought while this is got to be good so they got a load more of their loans that they had already had on their books bundled together and solve the risk off for the default for those as well and said look at Fed we are selling all the risk off we just don’t have any risk any more and then it got a bit complicated because then we got into what was the modern mortgage-backed security structure because the way JP M did this in rheumatoid malice for Hull on Sunday the way in this after the Masters deal the next bundle they did of the old stuff that they had on their books anyway that they bundled office is about 10 15 billion and the first of they opened in the Cayman Islands and off farm as a special purpose vehicle for it and thoughtful extra tax avoidance they bombed the the harm the suppose risking their and then they only let special purpose vehicle built the risk of themselves using that offshore special purpose vehicle for that and then sold chunks of that special purpose vehicle to other people who want to join in and invest in it and you’ll recognise that that’s the standard mortgage-backed security and scan everybody was pulling in 2007 before it all blew up when on ago this guy we stick with Basel because group Crown reasonably interesting is that the Fed still when convinced they said okay in this special purpose vehicle how much money has been put in to it to how much you know insurance money how much money is in their two back the possible losses on all these default risks that you’ve pulled off your main boxing New York how much money is lying offshore their how much of you sold that special purpose vehicle for amateurs there and they say well was only this much in which was a small percentage obviously needs is its only ensure it’s ensuring this bundle of Unite could be Procter & Gamble on all sorts of other major and triple-A rated US companies that I’m going to default licensor what’s the point in a swap win not completely happy because you got all this loan out you got this default risk that you say you’ve taken care off but the whole loan is still there there is still say you say that the risk is 5% but you still got 95% of your loan sitting on your books there if we go to give you a good Basel one reduction we want something done about that so they had to do something about the actual loan that was still on their books so they got to something called super senior because what they were doing the special purpose vehicles they were starting to trust those up to different levels of risk for that has in the junior the mezzanine and the senior where the junior risk was if any of these go-go bust your the one can pay in the junior one but we shall pay you as a bigger fee which is the biggest get interest rate the mezzanine medium one you will only pay if the junior ones have been wiped out and senior where you will only pay if the mezzanine and the journeys of being wiped out you got a very small fever that all arrange small ensure a interest rate but you knew your investment was safe if you like this is investing in the offshore special purpose vehicle right which was to ensure the small amount of risk on the books of bank so they called the books of the bank and loan super senior but they knew because it was above even senior that they would have to that they could only pay a fee that was pennies or an interest rate which was .00 nothing so how would possibly want that and they found arm first herbal deal with the first is a tiny G and in London they had our investment AIG is in assessment financial products Allied chief financial products Cassano running the outfit aims London ramp for a IgE issues which am the biggest insurance company in the world triple-A rated they could take on something like this which would be ensuring the super senior transfer pennies because there was no risk all it was was somebody comes into the office he signed a bit of paper and you get a small convert and an income stream which is very insurance like you got a huge risk that you are actually ensuring which is the major bulk of the loans on the JBM’s books or whichever bank understood that their books and but you know a is not in happen because you lobby off but with the often sure vehicle which is going to ensure the risky part and if these people are going to default anyway so it’s a little bit of money and nothing so AIG would start assigning these things and as other banks got into the hole’s way of doing things that were lots of these to sign because when they took the offshore package and the AIG in ensuring the super senior tranche of the debt on their books to the Fed who could arm twist Basel but that it was interior rules for the United States the Fed said okay you can you now only have to hold 20% of the 8% can do the is 1.622 dates 16 over that 1.6 now it’s only 1.6% you have two hold in capital reserve against those loans and that meant because all the Wall Street banks warp up against their capital reserve buffers as long as they got these derivatives jobs done with offshore accounts and then suddenly taking the super senior they could free up 1.66 .4 6.4% that they couldn’t use before they have to have anything known reserve account extra money that they could loan and they were wanted specially in the run-up to the credit crunch everybody wanted to be up against hard up against their reserve but buffers as much as possible and that started the idea that these derivatives are absolutely marvellous because you can imagine the arm mail generally male but the of the the utter pleasure of a bean counter if you don’t know what appeared never met bean counters and done any work with you don’t understand how strange their minds are these Abacus boys generally the boys the sump sometimes the girls that pretend to be boys in the old days on the banks book say before the mid-90s you have alone and the analysts would put a little note with it saying how much risk the was with this loan say to Exxon and that the unknown was bloody hell you know who Exxon ours is there then not going to default for goodness sake and that’s the acid tag of the risk and that none of the bean counters and put everything in columns and add everything up Well over a hate alright if you say so that now they were bringing to the bean counter alone which stayed on the books with the risk sold offshore and the whole risk of the loan sold the super senior the risk of ghostly bean counter that the loan could go to the bean counter and no note blank no risk soul has been Risk is because they can just put it in on the accounts that no risk in and see risk or if the risk or whatever then no contingencies at all it was just solid put it in, leave it there That the Orgasmic for the Fully Am a Bean Counters a Loved It and What That’s What We’ve Got There Are Better Stop That What Would Got Now for the Credit Crunch the Bean Counters Who Do All This Accounting I Keep Going on about This Is All Banking about Double Entry Bookkeeping and Balancing Things and Bean Counters Bean Counters They Are Now Getting All Sorts of Horrible Bits of Information in from Their People Says We Can’t Do These Derivatives Any More Because People Aren’t Buying the Offshore Staff and People Aren’t Even Buying the Super Senior Staff so There Are Now Presenting Loans Again to the Bean Counters with Little Tags on Them Saying Look with Looked into This Fellas past and They Look All Right in the Bean Counters Hate It so It’s a Great Big Tossup Now between They the Whole Desire Is to Stay with the Derivatives Model Where They Can Put on Their Boss Books No Risk Is That Sold the Risk off and They Just Do Not Want to Go Back to the Old Days of Having Analysts That Analyse the Risks of the Loans on the Books They Desperately Want to Go Back to the Derivatives Way of Doing Things and That’s Where We Are Now and It’s a Great Fight between Which Way It Will Go except There’s Not Really Much Fight Because You Can’t Fight the Bankers and As Longer As They Can Get the Derivatives Accepted by the Authorities That Then Can Come down and Squash the Derivatives and Then They Can Go out and Start the Confidence to Sell the Derivatives Again the Whole Derivatives Thing Will Kick off Again but Will the Authorities the Powers That Be Enough from the Fed the Bank Of England and Basel Let Them Go and Run on Again with the Derivatives Thing Because You Can See That People Are Paying to Sell Risk off and Have Your Books to Say I’ve Got No Risk on It Is Obviously Ludicrous Because You Can Have Counterparties for Always Derivatives All the Derivatives Every Time You Got the World Bank OECD IBM Exxon J P.M. That All Writing Contracts These Derivatives with Each Other for a Whole Derivatives of Got the Counterparty Risk and Written between Two People or They Come through the Broker and There’s Always an Element of That Can Break down and As Long As There Was One Element That Can Break down That Starts the Chain Reaction of It All Breaking down Because Nobody’s Got Any Faith in the Other People That Have Signed All These Counterparty Derivatives Are Generally the Whole Thing Has To Work All Half Derivatives Thing Just Won’t Work and They Don’t Think Going Back to Actually Judging and Balancing and Accounting the Risk on Their Books Is Just Nothing They Want to Ever Go Back to Something like That Derivatives Love or Hate Him the Banking System Is Wanting to Go Back to Them by
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