Last weeks market shenanigans were a real sight to behold. The story that shook me was the fact that the rapid rise in interest rates as a result of market overreaction to the economic change of direction signalled had cause interest rates to rise rapidly. We then find out that Pension funds have been using something called Liability Driven Investments (LDI) which, it is claimed can reduce the volatility of the pension fund liabilities. No, don’t ask me? However there are underlying layers of complexity with interest rate derivatives which pension funds were using to, presumably, make their lives easier. These are leveraged products and, guess what, when volatility increases on long term assets of liabilities then there is a significant change in long term values prompting the speculators nightmare, margin calls. Pension funds were caught short and started dumping assets. The potential for a market meltdown was there in plain sight. I have since read that the Pension Regulator actively encouraged the use of these techniques. One must ask the question why? The risk was clear enough: did they really understand what they were doing? I doubt it.
The short answer is I don’t know but I suspect it is not as bad as speculators or short sellers would have you believe. Certainly the once mighty bank has had its fair share of bad luck over the past few years. Some of its problems were undoubtedly non financial and surrounded less than professional actions by people who should have known better. Others however have shone a light on poor decision making, risky practices and a lack of serious understanding by decision makers. This weeks focus has been on the quality of the loan portfolio. There were questions to be answered after the collapse of Archegos and Greensill capital. Archegos exposed the fact that the bank was willing to throw money about to finance clearly speculative activity that helped lead to the (institutions) hedge fund, family office, whatever collapse. Mind you lots of banks have done this kind of stuff. Greensill was undoubtedly somewhat more complex but seemed to indicate a lack of detailed knowledge as to how the whole outfit was structured. Nevertheless the CDS market is buzzing with rumours and sometimes there is no smoke without fire. We haven’t heard the last of this but CS will probably see it through maybe without its very profitable wealth management division.
Bad news for those in need of a mortgage all over Europe apparently. There is almost nothing in the world that can happen that our overreacting financial markets cannot make worse. In the Eurozone a one size fits all interest rate structure is clearly inappropriate with some Eurozone states experiencing completely different rates of inflation than other. The Netherlands is around 17% inflation whereas France is considerably lower Nevertheless in the UK there is complete lack of cool heads. Hiking interest rates will increase volatility and destabilise what is a strong housing market. A more granular approach to business without the knee jerks would certainly be helpful.