> Essentially, the trade had little economic purpose—only an accounting one.
Yep, that's one of the first things you learn about when you take any kind of trading course. At a lower level in the cash equity markets you have something similar with wash trades.
The rule of thumb has always been, did you swap any risk, if not then consider you may have done something dubious, not always, but its a very good first pass.
> This month the bank agreed to pay $7.2 billion to resolve a U.S. probe into its subprime mortgage business, admitting it misled investors. Deutsche has paid more than $9 billion in further fines and settlements related to claims of tax evasion; violating sanctions against Iran, Libya, Syria, Myanmar, and Sudan; rigging the $300 trillion Libor market; and other alleged breaches of the law.
I think this is going to be the new normal for banks from now on until they get completely out of trading an market making, which is probably going to be never.
It's very hard to police a world wide distributed teams, who have many conflicting views, all of who get paid based on what they produce and don't have much long term incentive to see things any other way.
I mean, in this case even the risk team singed off on it. What more could a CEO do. At some level you have to trust your people to make money and do it without breaking the laws of every country you do business in, even if those laws can conflict.
Having said that, Deutsche bank is one bank that keeps coming up when fines and abuse in the baking system are in the news.
They allegedly wrote famed hedge fund Renaissance Technologies their infamous basket option put that let RenTech claim that its short term trades were actually long term captial gains instead by virtue of them owning the put written by the bank that just happend to include every single short term trade Rentech did over the year.
Deutsche got paid handsomly for writing the put and RenTech got the cliam long term capital gains vs short term capital gains.
I've said this before, but when the tell all book about RenTech is written, their genius will be confirmed but I think you'll find they did alot more shady things like the above to juice their returns.
>"It's very hard to police a world wide distributed teams, who have many conflicting views, all of who get paid based on what they produce and don't have much long term incentive to see things any other way."
Why is this hard for management to police their own departments? Other industries manage distributed teams just fine. I agree with your other points in that passage.
The real issues is that there exists a culture a criminality with little little fear of consequences. jail. The only way that's going to change is to start holding individuals accountable.
>"I mean, in this case even the risk team singed off on it. What more could a CEO do?"
Verify? These CEOs have insane compensation packages. They make more in a year than most people will in a lifetime. When questions about their insane pay packages arise, the party line always seems to be that they are worth it because they are "that good."
If they are that good then more should be expected of them. They should be conducting independent audits - "trust by verify" or do some innovating in the area of compliance. Their M.O. is always to blame someone else, the buck never stops with them.
Companies don't want to police their own departments. This is how lots of modern companies deal with laws they don't like. They commit to obeying the law, tell everybody not to do anything illegal, but at the same time place requirements and expectations on the peons that force them to break the law. Then the peons get caught, they tell everybody how it's not their fault, they told everyone not to do that. The peons get fired or worse, the company hires replacements, tells them not to break the law, gives them unrealistic expectations, and the cycle repeats.
Wow I was downvoted for saying that management needs to be held accountable for criminality?
The cycle repeats because there is no disincentive to stop it. How many people went to jail after the 2008 crisis? I think you could count them on one hand and still not use all you fingers. Nobody will go to jail for Wells Fargo fraud either.
Downvotes happen. Maybe someone fat fingered. Maybe someone doesn't like you because of a different post. No point in dwelling on it, and in any event often enough it swings back later.
This is the unspoken foundation of the "sharing economy". You get a big pool of individual actors to make exchanges with each other in a marketplace like the ones provided by Uber, TaskRabbit, etc.
The market takes its little cut of every transaction, but takes zero percent of the risk. That's all passed on to the individual participants.
Car break down? Not Uber's fault. Get hit by a drunk driver? Lyft don't care. Have an allergic reaction to your latex gloves? Doesn't have anything to do with TaskRabbit as far as they're concerned.
The core of the challenge is our measuring stick --- money --- is a too-aggressively lossy transaction representation system, yet it is press-ganged into use as such when it really should only ever represent just the money itself instead of all the imputed characteristics ascribed to it by current mainstream economic thought. All sorts of desirable information by involved parties is detached from the money when the transaction completes, and we currently have very incomplete mechanisms and highly fragmented platforms for conveying that information.
Taking this down to a more concrete level, if every transaction and popular properties in a market were recorded and undoxx-ably published blockchain-style, then market actors who try to externalize costs will find those properties they are externalizing upon others added to the system, and their activity shunned more quickly. Much rent-seeking and externalizing behavior today in businesses (especially gig economy-pitch-based businesses) relies upon a great deal of extreme asymmetric information postures between the parties, possible because of the much more complex information ecosystem we operate in as economic actors today.
Trading is an information war where the only edge you can get is through asymmetric information about the deals and the products/services (violence being a special case). I wonder what trade would look like with a complete transparent process.
a good analysis. Would be great to take a look at how much of the cost saving is actually reduced interaction with externalities that are now costed out or left to the final-service-provider instead of the "platform.
How do you incentivize "produce less goods/generate less profit"[1]? That's a genuine question. We can barely de-incentivize flat-out criminal behavior. The line between malice and negligence is a tenuous at best. DA's feel lucky when they get a Grand Jury to indict which almost always results in a plea bargain being offered by the State, accepted by the indicted, and stamped on through by the Judge hearing the case.
Auditors were supposed to make sure books were GAAP-compliant. That was their entire job. Even they can't/won't keep up (RIP Arthur Anderson). And that whole "you have to file an 8-K with teh SECevery 3 months with the SEC" is limited to publicly traded financial institutions within the United States[2].
To make an analogy, the law can barely keep up with tech (see: amorphous definitions of 'data collection', 'meta-data', is your cryptographic keyphrase protected as a fifth amendment right, is PGP a "munition"?[3]). Financial markets are innovating at just as quickly a rate as we are.
So, in a modern day, how do we prevent 'cooking the books'? I assert that the problem is lack of transparency. Here's an idea that probably has many major issues as I haven't ruminated on it at all, but let me give it a shot: require all transaction data[4] to be independently audited by any stakeholder at any time. As a stakeholder who is keeping my retirement money with this institution I'm highly motivated to ensure that whoever is managing my money is doing so in what I deem to be a proper fashion. Access to their books (obviously with the account information/PII scrubbed), maybe after a business week of buffer time (to allow for some padding for any tactical content that may be in the current positions) should be perhaps be made available.
My second assertion is this will not only keeps the institution obligated to be 'honest' with their reporting as obligated to their stakeholders, but has an auxiliary benefit of incentivizing their competitors to act as very motivated auditors as they scrutinize their competitors books to uncover any malfeasance.
Since regulatory bodies can't keep up, _ensure that all actors within the market actively keep each other honest_. Sure, they can collude but collusion is far easier to detect and prosecute than internal book manipulation.
----
[1] Subsidizes to under-produce (big agri. and the like) notwithstanding
[2] There's nothing preventing a pension fund to go take all of GM's money and put it into a private hedge fund, throwing tons of money at a PE firm, becoming a large stake holder in a real estate investment group, or throw their money into any sort of 'unconventional financial entity'. None of these have public reporting obligations, and their federal obligations are limited to tax entities ,co-operating with FINRA, and (if they are using instruments which fall under the regulatory domain of the SEC, then also) the SEC.
>If they are that good then more should be expected of them. They should be conducting independent audits - "trust by verify" or do some innovating in the area of compliance. Their M.O. is always to blame someone else, the buck never stops with them.
Isn't that a little extreme? $500MM sounds like a butt ton of money to you and I, but Deutsche Bank has over $800B aum. To successfully audit $800B in assets a year he'd need to look at almost $2.2B of deals a day, assuming there's 0 fluctuation in earnings per day. Then he'd have to no time for figuring out what units are the most profitable and growing those business. He'd spend 100% of his time assessing risk, kind of like that department he hires to handle risk assessments. Even if he spent an hour a day doing random spot checks of deals, their are so many sour ones to clean ones that it'd almost be a waste of time.
The person bearing overall responsibility to appoint the right people to build a system of internal controls that can audit whatever volume of trade they are doing. In this case it seems that the top people knew all about this trade and it is clear that the accounting treatment of a trade that spreads a loss into the future would be 'fair value'. IE 0. So if the courts find that this actually happened then of course the execs are culpable.
People legitimately disagree about value. Investment horizon is a large factor. Two teams can do the opposite side of a trade and both profit on different horizons. Usually the agreement or disagreement is statistical, executed by a program in small fractions of a second. There is almost always some noise involved at the exchange, sometimes even some intentional randomness. It's not the same as getting people talk to each other about a project.
"Deutsche has paid more than $9 billion in further fines and settlements related to claims of tax evasion; violating sanctions against Iran, Libya, Syria, Myanmar, and Sudan; rigging the $300 trillion Libor market'
None of these are a byproduct of programatic trading.
> in this case even the risk team singed off on it. What more could a CEO do.
This doesn't seem like a valid excuse. The risk team will just tell you the probability of being fined at various levels. If the risk team tells you "there's only a 0.1% chance you will get caught for this murder" and then you get caught murdering someone you can't just say "but the risk team said I probably wouldn't get caught!"
The laws have gotten increasingly vague, and enforcement increasingly discretionary, so you never know which rule (if any) will be applied to what action. As such, no one can guarantee that any action is 'legal', so the risk team will always say there is a 1-10% chance of being fined/prosecuted.
These enforcement actions have become an unavoidable cost of doing business.
We want a world where people "deserve" the things they have/can-do; but I don't think we will ever get close to that (we sure can try tho)
It happens the same way in an individual level; the "wolf of wall street" (Jordan Belfortm) did a lot of illegal things; but despite being found guilty and forced to pay fines he is still better off for having done them (~10M offshore money and book/movie money among others).
Heck, it even happens in social interactions, for example kissing a random woman in the street without asking can give someone jail time (sexual harassment and what not) but if he is lucky she may fall for that; they may even get married later on.
I lead a department at a medium sized global business. I recently approached our internal counsel and external specialists about day to day legal issues my team encounters. I wanted to know: Can, Can't, Should, Shouldn't. All I got was a statistical probability of getting in trouble and a summary that stated do whatever, the chances of getting caught and the chances of that even mattering are nil. Better off doing what makes you most effective, even if that entails breaking the law.
When you look at it clinically it makes sense. Quite the slippery slope.
Is it really so much that the current environment rewards companies that take regulatory risks, or that regulatory risks are so pervasive you can't do business without them?
There is some risk of harm of bad dealing at almost every level, but we try to pay attention to the people with the most financial power because they have the greatest ability to do harm. And of course the more incentive there is to subvert the laws. Probably any simple view of this issue is wrong.
The financial instruments have become so complicated that I think the laws need to be vague to ensure that there is power to do something if an investigation happens.
At the same time there is complaints about how complicated the tax codes have become.
At some level you have to trust your people to make money and do it without breaking the laws of every country you do business in, even if those laws can conflict.
I have the sense that in many of these cases, the laws actually don't conflict. That is, they did things that are illegal in every country they do business in, and that's without even touching SarbOx.
You have an accurate assessment. It is the prisoner's dilemma problem: Do what others are doing & do it first. Or have them do it get, bet bigger and acquire you, and you'll end up doing it anyway.
There is a subtle historical irony on this deal happening with an Italian bank.
Italian banking, including the bank in question, got its start back in the middle ages by getting around prohibitions on usury with similar "guaranteed to lose" bets on currencies. The bank would give the borrower money in one currency now, and the borrower would give the bank back a different sum of money in another currency in 6 months. Given currency fluctuations, it was theoretically possible for the bank to lose the bet. Given the sums involved, this was very unlikely to happen in practice.
(Jews had the same commandment against usury, but interpreted it to only apply to other Jews. They could lend to Christians all that they liked, and did. That is where the connection between Jews and moneylending got its historical start.)
A lot has changed in the intervening centuries. The prohibition on usury was dropped, first by the Protestants and then by the Catholics during the counter-reformation. Banks have been regulated. And now the original workaround to allow loans at interest is seen as unacceptable. And so the Italian bank has been taken down by a deal that is very similar to the ones that got it started in the first place.
Somehow I need (as an Italian) to underline how the Monte dei Paschi di Siena was founded in 1472 (yes, that is 20 years before Columbus found America thinking to make a new route to India) and had prospered until the new economists/geniuses took over in the 90's.
In other words "how to make five centuries (500 years!) of experience go waste".
A loan doesn't change your profit for accounting purposes - you gain $$$ in cash (asset), but have the same $$$ as a loan (liability) on the other side of the balance sheet.
I suppose that with a loan it would be transparent that the money "gained" would have to be repaid later, while in the case of a sure to lose bet, the price of the derivatives could have been tweaked so it would be apparent only later that the money would be lost.
So this one investigation managed to neutralise all people at Deutsche Bank that were doing same things that most other banks are also doing - making highly risky semi legal investments and reaping profits. So now without those kind of people in Deutsche Bank the have no way of competing on global markets and will loose money while other bankers reap the benefits. Nicel done. Congrats to American bankers.
Whatever happened to the "Greece crisis"? Deutsche was one of the banks on the hook for that mess, and now you hear nothing about it. Did little ole Greece have billions of dollars in a dusty treasure chest somewhere? All this financial crap is a scam...
https://news.ycombinator.com/item?id=13047056
> Essentially, the trade had little economic purpose—only an accounting one.
Yep, that's one of the first things you learn about when you take any kind of trading course. At a lower level in the cash equity markets you have something similar with wash trades.
The rule of thumb has always been, did you swap any risk, if not then consider you may have done something dubious, not always, but its a very good first pass.
> This month the bank agreed to pay $7.2 billion to resolve a U.S. probe into its subprime mortgage business, admitting it misled investors. Deutsche has paid more than $9 billion in further fines and settlements related to claims of tax evasion; violating sanctions against Iran, Libya, Syria, Myanmar, and Sudan; rigging the $300 trillion Libor market; and other alleged breaches of the law.
I think this is going to be the new normal for banks from now on until they get completely out of trading an market making, which is probably going to be never.
It's very hard to police a world wide distributed teams, who have many conflicting views, all of who get paid based on what they produce and don't have much long term incentive to see things any other way.
I mean, in this case even the risk team singed off on it. What more could a CEO do. At some level you have to trust your people to make money and do it without breaking the laws of every country you do business in, even if those laws can conflict.
Having said that, Deutsche bank is one bank that keeps coming up when fines and abuse in the baking system are in the news.
They allegedly wrote famed hedge fund Renaissance Technologies their infamous basket option put that let RenTech claim that its short term trades were actually long term captial gains instead by virtue of them owning the put written by the bank that just happend to include every single short term trade Rentech did over the year.
Deutsche got paid handsomly for writing the put and RenTech got the cliam long term capital gains vs short term capital gains.
https://www.bloomberg.com/news/articles/2014-07-21/renaissan...
Side Bar:
I've said this before, but when the tell all book about RenTech is written, their genius will be confirmed but I think you'll find they did alot more shady things like the above to juice their returns.