The end of the year is nigh and not a day too soon for some investment bankers. Some say, with the $500 billion of subprime losses this year, this has been a major downer for the markets long-term. Others say
that $500 billion is what the stock markets can lose in a day, so don’t
worry about the credit crunch of 2007 … it’s only a blip.
I blogged about the ups and downs of the credit crunch, the bonus season, algorithmic trading
going through strange hiccups and all sorts of other stuff. It’s a bit
of a far cry from the start of year, where the discussion was all about
the search for alpha
and how brokers would start using complex algo to bridge across
multi-asset strategies. That is not to say they are not doing this,
just that they will be doing it with far more risk management focus than ever before.
After all, in the investment markets, it has been quite a year. In
particular, the summer’s turmoil in the financial markets, the like of
which has not been seen for over two decades, meant that Citigroup, Merrill Lynch and others posted major losses and ousted CEO’s. Meanwhile, we had one of the most shocking runs on a UK bank, Northern Rock,
for years. Some people thought for hundreds of years but actually a
similar event occured less than twenty years ago with Town &
Country Building Society in 1991, a small UK community-style bank.
all of these upsets, and half a trillion dollars thrown down the tubes,
we all wonder what is going on. Has the world gone mad or did someone
just pull the plug on the financial stabilisers we learned to live with
in recent memory?
No, nothing has gone mad. We just happen to
be seeing one of the major explosions erupting in financial markets
that occur on a fairly regular basis.
After all, think back a
few years and we had a bad few days in 2001 when the internet
investment boom ended and many lost millions. Equally, America has
had a subprime style mortgage crisis before in the 1980s. In fact, the
financial markets seem to boom and bust on a fairly cyclical basis, and
some would say that you should view it this way, e.g. investment banks
boom and then bust and then boom and then bust.
this mean for all of us today? It means being circumspect and
thoughtful. It means thinking very carefully about the knock-on
effects of what we do and how we invest.
For example, the
credit crunch and subprime crisis was incredibly obvious in the way it
brewed … just that no-one was watching the kettle. What was so
obvious? Well, lending to people who could ill-afford to pay back on
the basis of a piece of collateral called a house. Now, the house
price was rising, but only because of al the irresponsible lending.
All of this lending was then wrapped up in complex derivatives in the
investment banking operations and laid off to the capital markets
through structured investment vehicles (SIVs) and collateralised debt
obligations (CDOs). The fact that the debt had collateral that was
worth half of its book value, inflated through the very SIVs and CDOs
that funded it, was never known or considered.
So the point
is this. You create an artificial bubble through bank processes that,
on the one hand, inflate the market through unsubstantiated loans and
borrowings whilst, on the other, offset the risk through wrap-around
products that hide the true credit risk laying underneath, is something
the markets and regulators and governments never want to see again.
And how do you avoid this ever happening again?
an enterprise risk view of course. Sounds easy, but this is very hard
to deliver in practice. What this means is that for each risk you lend
against, you clearly understand the underlying picture and exposure it
creates for the bank. This is sound economic and investment theory but
it was thrown aside in recent times, as clearly demonstrated by the
credit crunch financial crisis. Only by managing total risk from the
end borrower or investor through to the collective investment vehicles
used in the investment operations, can a bank truly manage its
enterprise risk. That is the real point: enterprise risk.
me a bank who can manage the totality and I’ll show you a sound bank.
Now, there’s aren’t a large number of those around these days, are
Meanwhile, from the technology perspectives, this year has been all about low latency, high throughput.
We’ve seen increasing moves to manage latency and make this a
differentation, with my favourite story of the year being the bank that
moved their routing for Tokyo deals that originally went from London
via servers through New York to using servers through Moscow, as it
saved them 25 milliseconds. Will wonders never cease?
technology that keeps evolving is the algo stuff. Last year, it was
simple black box algo trading starting to get a bit sexier with
cross-asset class instruments. Equally, the idea of simluated trading
strategies and real-time illustration through graphics of the success
or failure of the trading strategy.
This year, the hot topic has
been news algorithmics and the idea of embedding any news related to a
stock ticker into the real-time trading arena through automated
reference data is becoming a hot topic. It doeesn’t mean humans ever
go away, but it does mean that we see a market that is very different
in structure and volume and value thanks to low latency, highly
sophisticated, algo-automated markets.
Finally, we can’t forget that 2007 was the year of MiFID.
It’s here and we’re all going yippee, aren’t we? Some analysts who
aren’t that familiar with the markets think it involved hardly any
issue or impact, whilst the markets have worked with me to write a book
about the subject, and seem to be saying it’s been quite an upheaval.
This is why we have new exchanges
like Turquoise, Chi-x, Equiduct, Virt-x, Smartpool and company. Then
add the existing and newer dark pool and algo systems, e.g. Goldman
Sachs Sigma, JPM’s Aqua and Arid, Credit Suisse’s Crossfinder etc, and
you can see we have many new trading venues across Europe to interface,
integrate, work with and deal with.
The MiFID monologues are well mantained on Finextra and now I just look forward to the first Best Execution trial of 2008. More on this next year.
back to the question: will capital markets survive? Of course they
will. I think they’ve seen more volatility and change this year than
in the past five years, but change is good. It makes us move on.
Meanwhile, as the economist Paul Samuelson stated, stock markets with
all of their ingrained volatility are not the best recessionary
indicator as, if you’d followed their advisory trends, they predicted
nine out of the past five recessions.
Back here tomorrow for a review of Retail Banking 2007.