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Charlie Munger Quotes

Charlie Munger quotes are among the best zingers to Wall Street in existence. Known as Warren Buffett’s folksy business partner, Munger to has a way with words that makes him fun to listen to. Here are a few that stand out to us.

Charlie-Munger-quotes

“The major non-investment banks have by and large misbehaved in consumer lending. They have had a marketing model which is the equivalent of a liquor company that seeks out the people very susceptible to alcoholism, and tries to suck them into alcoholism.” source

charlie munger quotes

“To say that derivative accounting is a sewer is an insult to sewage.”  source

 

Charlie Munger quotes
“The derivatives traders have tended to rook their own customers. It’s not a pretty sight. It’s a dirty business.” source

***

While it’s unfortunate that Munger and Buffett invest in some of the very products and banks they denigrate, we strongly endorse the sentiments in the quotes above.

For more on derivatives, see our derivatives timeline and our post “What Are Derivatives, and Why Are They Dangerous?”

 


The New York Times Exposes Why Congress Does Wall Street’s Bidding

wall street congress
The New York Times DealBook published an article late last night exposing why Congress does Wall Street’s bidding. We present a summation of the key points in the image above, and here are the corresponding passages from the article:

In a sign of Wall Street’s resurgent influence in Washington, Citigroup’s recommendations were reflected in more than 70 lines of the House committee’s 85-line bill. Two crucial paragraphs, prepared by Citigroup in conjunction with other Wall Street banks, were copied nearly word for word. (Lawmakers changed two words to make them plural.) …

The lawmakers who this month supported the bills championed by Wall Street received twice as much in contributions from financial institutions compared with those who opposed them…

At one dinner Wednesday night, corporate executives and lobbyists paid up to $2,500 to dine in a private room of a Greek restaurant just blocks from the Capitol with Representative Sean Patrick Maloney, Democrat of New York, a co-sponsor of the bill championed by Citigroup.

(Note: 70 lines/85 lines = over 80%, as reflected in our image above.)

The entire article is worth reading in full. It’s a good look at how legislation goes through Wall Street to Congress to eventually affect each of us. (After all, the bill loosens rules on derivatives trades, which were at the heart of the financial crisis.)

We need a political system that allows for equal representation. Simply put, there likely isn’t a single group advocating for a safer Wall Street that could afford to pay $2,500 for a meal to dine with a Congressman. For many of us, $2,500 exceeds our entire month’s budget for groceries many, many, many times over. So we’ve got a system where certain ideas aren’t given proper voice, and without a voice how can one be heard in Congress? We need to restore some sense of equality in the system.

To that end we strongly support advocacy groups like Rootstrikers, which argues for getting the money out of politics. If you haven’t heard Rootstriker founder Lawrence Lessig’s TED talk on this topic, we recommend it. (Actually, we recommend it even if you have heard it.) Lessig reveals the murky heart of the problem.


Derivatives Timeline: A History of Financial Fiascos

Note: Derivatives weren’t the sole cause of the financial crisis, but they were one crucial factor. The evidence in the timeline below demonstrates that without change, we’re bound to see more derivatives-ignited fiascos. If too many of these fiascos occur at once, we’ll risk experiencing another crisis.

Critics might take issue that we use the word “gamble” here, but given the uber-speculative nature of these transactions, we feel it’s merited. We also recognize that there are many types of derivatives and that the timeline here only focuses on the more dangerous types.

derivatives timeline

As we’ve stated elsewhere, we’re not calling for endless pages of regulation and red tape. The financial industry has been flooded with thousands of pages of regulation—much of which ends up hurting smaller lenders. Instead what we need are a few simple reforms to make derivatives transparent. We also need to ban a few of the more egregious derivatives trades (including credit default swaps).

While all derivatives aren’t harmful, the sheer scale and opacity of this market means that our economic future will continue to be fragile unless we demand reform and protest firms that engage in these practices by switching from them.

Also see: What are derivatives and why are they dangerous.

Sources

People
Wendy Gramm (source for quote)
Nick Leeson
Larry Summers (quote #1quote #2)
Brian Hunter
Alan Greenspan (quote #1quote #2)
Joe Cassano (source for quote)
Howie Hubler
Bruno Iksil

Firms
LTCM
Enron
AIG
Lehman Brothers
MF Global


What Are Derivatives and Why Are They Dangerous?

warren buffett derivatives

As we recounted in the preface to our derivatives timeline, though derivatives were not the sole cause of the financial crisis, they were a crucial factor.

What are derivatives?

Derivatives are financial instruments whose value is derived from an underlying asset (stocks, bonds, commodities, etc.). Traders can swap interest rates, take bets on whether a firm will go bankrupt, safeguard against future asset price increases, etc—all under the ugly umbrella term derivative. The concept of a derivative has been around for centuries, but their use has recently exploded, as demonstrated in our timeline and in the images below.

derivatives jpmorgan chase bank of america citi

Worldwide Derivatives

Derivatives are recorded in what’s termed as notional value, which just equals the value of the underlying asset on which the derivative is based. So if the underlying asset equaled $500 million, the notional value would be $500 million even though the megabank doesn’t actually trade $500 million. They just trade the derivative. It’s complicated if you’re totally unfamiliar with this market, but at least you can see why the global notional value for the derivative market can reach into the hundreds of trillions as shown above. It’s because the megabanks are recording the notional value.

Some traders don’t think people should worry about the notional value since it’s not referencing what is actually being traded. But the notional value matters because if the underlying asset turns toxic, then the derivative itself does too.

We saw this in the 2007-08 crisis: when underlying mortgages went bad, then all the derivatives contracts on top of those mortgages also went bad, and this worsened the crisis tremendously. So the notional value of derivatives matters, and you can see from the charts above that Wall Street in 2012 is a completely different world compared to Wall Street in 2000 (when the total notional amount was less than $100 trillion). In other words, the dangers of the derivatives market are still very much with us.

So, why are derivatives dangerous?

1. Derivatives allow for phony accounting

Charlie Munger once asserted that “to say that derivative accounting is a sewer is an insult to sewage.” Well said, Munger. Derivatives allow firms the option to record profits today that will supposedly come tomorrow. This way a firm can put on a good pony show today and get a better stock price. All is well—unless tomorrow’s profits don’t arrive as expected (because of an unforeseen fiasco). If this happens a seemingly healthy firm can suddenly implode, all because of phony accounting—as happened with Barings Bank, Enron, and Lehman Brothers.

2. Derivatives obscure the market

Several derivative contracts can be written on a single underlying asset, a feature which adds enormous complexity to financial markets. A derivative contract on one asset might be traded in Asia and the US, while another contract on the same asset might be traded in Europe. What’s more, the majority of derivatives are over-the-counter, meaning they aren’t standardized or traded on public exchanges. So the terms of each contract can vary greatly and so the implications and interconnectedness of this market can be impossible for regulators and traders to see clearly. When markets melted during the 2007-08 crisis trading halted in part because market players couldn’t readily discern which firms were on the brink of collapse and which firms were safe. This was partly because of all the derivatives contracts on top of the crumbling mortgage market.

3. Derivatives concentrate risk

Four US megabanks—JPMorgan, Bank of America, Citi, and Goldman Sachs—have a notional amount of $214 trillion in derivatives exposure. That’s more than 30% of the worldwide amount just in four US banks. When firms have such concentrated derivatives exposure, they leave themselves open to surprise losses like last year’s $6 billion London Whale loss at JPMorgan Chase.

4. Derivatives allow megabanks to take on more debt

Megabanks trade risk via derivatives contracts to another firm while keeping the underlying asset on their books. This way they can bypass capital requirements and take on more debt. This in turn allows them to make more trades, but it also means that if a sudden downturn surfaces in the markets, the firm which borrowed way beyond their means may quickly go bankrupt. Lehman Brothers experienced this after they’d borrowed 30 times more money than they had in reserve. In that case a relatively small loss of 3% meant that Lehman no longer had reserves (i.e. capital), and they therefore collapsed.

5. Derivatives deceive smart people into thinking they’ve eliminated risk

It keeps happening, over and over. “The smartest men in the room” think that they’ve figured out some way to eliminate risk completely through the use of derivatives. One amazing example of this is the tragedy of Long-Term Capital Management. A group of highly intelligent economists and traders created a hedge fund in the late 1990s centered around a formula which supposedly hedged risk completely. For the first few years, the fund made enormous returns and the creators of the formula even won the Nobel Prize for economics. But then they borrowed more and more money thinking they were safe in doing so (similar to Lehman), and when a series of unpredictable events occurred in world markets, they lost billions of dollars and put US markets in danger. Their downfall should have been a warning sign about the dangers of derivatives-related risk, but several other firms suffered similar fates in the following decade. If things remain the same, we’ll see the same results.

Interested in learning more? See our derivatives timeline.


Derivatives, the Ticking Time Bomb

derivatives charlie munger quotes

It’s like this: Traders and lobbyists on Wall Street (with the help of Congress) have rigged the law so that in the event of a bankruptcy they and their clients will be the first to receive payouts. This is great for them because it means they can be relatively reckless in a lucrative market without facing extremely harsh losses when things go bad.

It’s not so great, however, for the rest of us. As shown in an article by Ellen Brown, in the event of another large-scale derivatives blowup, FDIC insurance will be strained tremendously. After all, the derivatives market represents trillions of dollars and the FDIC can only tap into $25 billion in reserves and their $100 billion line of credit from the Treasury before it has to turn for backing from the US government (which would have an incredibly difficult time pulling off another $700 billion bank bailout).

This is not to say that we should all bunker down for the inevitable meltdown. Instead it’s just to say that our current laws make the system insanely fragile, and it’d be smart to change the laws now, before another crisis. As long as JPMorgan Chase has trillions in derivatives directly tied to their depositor’s money, for instance, it’d be foolish to assume that in the event of a large-scale derivatives meltdown their depositors wouldn’t feel the stress of the downturn, especially since the players in the derivatives market get priority treatment.

We need to change the system before we get (more) hurt by it. Petition to break up the big banks, separate derivatives markets from deposits, raise equity requirements, etc. But also switch your bank. Local lenders aren’t part of the derivatives markets. They’re focused instead on promoting small business and local lending.


Info-Comic: How Banks Became Casinos

This info-comic, How Banks Became Casinos, offers a bird’s eye view of how banking has become more dangerous and risky in recent years. If you want to understand more about the situation beyond this simplified info-comic, we recommend these posts:

Our Financial Crisis Reading List
What Are Derivatives, and Why Are They Dangerous?
A Derivatives Timeline
Break Up The Banks Already
Our Too Big To Fail Page

And now, the info-comic: How Banks Became Casinos

How Banks Became Casinos

 

Some quotes to keep in mind:

Neil Barofsky, former Inspector General for TARP: “Pretending that Dodd-Frank solved all our problems, as some Democrats do, or simply saying that big banks won’t be bailed out again, as some Republicans have suggested, is unrealistic. Congress needs to proactively break up the “too big to fail” banks through legislation.”

Brooksley Born, former chairman of the CFTC: “too big to fail is the primary problem” and “the Glass-Steagall Act, before it began to be eroded by the bank regulators, was a good idea.”

James Bullard, president of the St. Louis Fed: “We do not need these companies to be as big as they are … We should say we want smaller institutions so that they can safely fail if they need to fail.”

William Dudley, president of the NY Fed: “We are a long way from the desired situation in which large complex firms could be allowed to go bankrupt without major disruptions to the financial system and large costs to society.”

Camden Fine, president of ICBA: “Consolidation in the banking industry and the emergence of financial institutions with explicit government guarantees against failure haven’t exactly contributed to an economic boom. It’s been just the reverse—they triggered an economic collapse.”

Richard Fisher, president of the Dallas Fed: “Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size—more manageable for both the executives of these institutions and their regulatory supervisors.”


Gawker: “Break Up the Banks”

gawker break up the banks
We don’t typically look to Gawker for opinions about the Wall Street banks, but Hamilton Nolan has a good piece there called “It’s Time to Break Up the Big Banks.” It’s worth reading in it’s entirety, but we particularly liked this quote (pictured above): The tendency of a few massive companies to monopolize industries is good for the companies, but bad for you, the consumer.”

It’s a simple concept, but if more people realized just how bad these monopolies are (did you lose any pension money during the financial crisis? are you a taxpayer who has to contribute to the bailouts?), they would be acting more boldly to reform Wall Street.

Nolan also quotes a section from Nassim Taleb’s The Black Swan, which was published in 2007 and which we recommend. Before the financial crisis struck, Taleb warned that our concentrated banking system would lead a severe fiasco. He was right. Here’s the quote from the book: “We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogenous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur… I shiver at the thought. I will rephrase here: we will have fewer but more severe crises.”

SwitchYourBank.org is, at its core, a call to return to the “diverse ecology” of small lenders. The Wall Street banks are bigger than they were in 2007, and they’re still flying high with risky derivatives trades. It’s time to end the status quo.


Barry Ritholtz Quote + Ritholtz Interview On Derivatives

barry ritholtz quote

We like this Barry Ritholtz quote (source) because it succinctly captures how incredible the lack of prosecution on Wall Street has been since the financial crisis.

Ritholtz was also part of a 15-minute Bloomberg interview that sums up a central reason why TooBigHasFailed.org exists: to inform people about the dangers of Wall Street excess. The video is somewhat technical, so we’ve included a summary and some excerpts below.

Summary:

1. The global derivatives market is enormous—5 to 10 times global GDP, depending on how it’s measured.

2. The vast bulk of derivative dealings happen on Wall Street. These banks are mostly very cautious and have positions on both sides of each bet. But the shear scale of the derivative market means that a slight mistake could totally wipe out a bank’s capital.

3. In 2000 a law passed that declared that derivatives were to be totally unregulated. This law should be reversed so derivatives can be treated like every other financial instrument. Until that law is repealed regulators will continue to have a very difficult time understanding the total derivatives exposures in the market.

4. Wall Street doesn’t want derivatives regulated because these transactions bring in huge profits, and even “subsidize the rest of the business,” according to Whalen.

5. It’ll take another crash for us to finally see true regulation.

Note: The hope of SwitchYourBank.org is that the public will become informed enough about this issue to demand reform before another derivatives-related crash hits.

Excerpts:

INTERVIEWER: Is size alone [of the derivative market] reason to embark on a big regulation campaign?

WHALEN: Well it is, because ultimately these are gaming instruments. Since the size of the market is so much larger than the underlying economy … then by definition it’s speculative. So that’s the first point. Going to Barry’s point, look at the large bank holding companies that are the major dealers—JPMorgan. A 7-basis point move in their aggregate derivative book wipes out their capital. 7-basis points. So when you look at the scale of the activity, the bank at JP is almost trivial compared to the derivatives book. The derivatives book is, in fact, the driver of the business, and whether you’re talking about the London Whale, or customer’s activities, whatever it is, these people are playing in illiquid, highly-levered instruments that most people don’t fully understand in terms of their performance, so by definition it’s speculative.***

RITHOLTZ: You’re taking two parties who hopefully both are solvent, but we really don’t know, and they’re making a bet as to a future outcome of something that has pretty significant ramifications. If it’s about something that you have a vested financial interest in, well clearly that’s an insurance product. You can insure your own home, you can insure your building, you can insure your portfolio, and therefore there should be some insurance oversight of this. On the other hand, if I’m speculating on his house, well then that’s gambling, and it’s up to the gambling commission to make sure that all parties leave the table and the trade actually goes through.

***

WHALEN: Obama understands perfectly, and so does Tim Geithner because, as Barry said, Geithner’s the guardian of Wall Street. But the thing is, the big banks aren’t that profitable. The supernormal returns that they earn on derivatives subsidize the rest of the business. And this has been the case for 20 years.

***

RITHOLTZ: There’s nothing wrong with getting rich slowly. You open up a reasonable-sized bank, you have a few branches—it’s a nice business. You’re just not going to get wealthy overnight.

WHALEN: But Wall Street doesn’t want that. Wall Street has turned the top 5 banks into a relatively high-beta, high-volatility place. … To Barry’s point, [in] the old-fashioned banking business, the common equity was a bond. People would keep that stock for generations, they didn’t even think about it because it was an income play, it was a credit play. It wasn’t a trading vehicle. So this whole notion that the financials should be 20% of the S&P 500, and they should have earnings north of XYZ, doesn’t fit that old world. That’s part of the problem.


Paul Volcker ATM Quote: “I wish someone would give me one shred of neutral evidence…”

paul volcker quote atm

Here’s a trenchant quote from Paul Volcker, former Fed chair. He even goes so far as to say that “The only thing useful banks have invented in 20 years is the ATM.”

Volcker is criticizing the rigamarole in the megabanks. The so-called “innovations” like:

Credit-Default Swaps

Credit default swaps can serve as a form of insurance, but they also allow traders to bet on whether a firm or a country (e.g. Greece) will default on its debt. In such cases, Trader A bets that the firm or country won’t default and Trader B bets that it will. Trader B makes regular, small payments to trader A, unless the default occurs, in which case trader A makes an enormous payout to trader B. It’s a gamble.

See our full writeup on credit-default swaps here.

Mortgage-Backed Securities

Everyone understands that the housing market tanked in 2007-08. What’s harder to grasp is how Wall Street was involved with it all. It’s complicated. But essentially it boils down to what Nate Silver pointed out in The Signal and the Noise: “For every dollar that someone was willing to put in a mortgage, Wall Street was making almost $50 worth of bets on the side.” The boring, technical name for these bets is “mortgage-backed securities.”

See our full writeup on mortgage-backed securities here.

Over-the-Counter Credit Derivatives

Derivatives are financial instruments whose value is derived from an underlying asset (stocks, bonds, commodities, etc.). Traders can swap interest rates, take bets on whether a firm will go bankrupt, safeguard against future asset price increases, etc—all under the ugly umbrella termderivative. The concept of a derivative has been around for centuries, but their use has recently exploded.

See our full writeup on derivatives here.

Rather than leading to net economic growth, each of these “innovations” have led to enormous economic losses.

- Source for the Volcker quote. Also here.



wall street banks wall street banks wall street banks wall street banks

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