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Will Fat Cat FSA do anything about this?

Regulatory Arbitrage, the Latest Edition 2 comments

by: The Baseline Scenario September 18, 2009 | about: BCS    

The Baseline Scenario

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By James Kwak

Gillian Tett has the latest perspective on a curious deal that Barclays (BCS) did earlier this week (hat tip Brad DeLong). The deal goes something like this. Two former Barclays execs are starting a fund called Protium Finance. Protium has two equity investors who are putting in $450 million. Barclays is lending Protium $12.6 billion. Protium is using the cash to buy $12.3 billion in what we used to call toxic assets from Barclays. Protium’s 45 staff members get a management fee of $40 million per year (presumably from the equity investors, although that seems steep). Returns from the investments will be paid as follows, in this order (and this is important): (1) fund management fees; (2) a guaranteed 7% return to investors; (3) repayment of the Barclays loan; and (4) residual cash flows to the investors.

Barclays emphasized that it was not participating in regulatory arbitrage, because it is keeping the toxic assets on its balance sheet for regulatory purposes. That is, because it has a lot of exposure to those assets through its huge loan, it will continue to hold capital against those assets. So far so good.

But regulatory capital arbitrage is only one kind of arbitrage. For ordinary accounting purposes, the toxic assets are not on its balance sheet. So if they fall in value, Barclays will not have to recognize a loss – at least not until Protium defaults on its loan, which could be as far as ten years in the future. So the bank has the same true economic exposure, but can pretend it isn’t there for a long time.

Or does it have the same true economic exposure? If things go badly, yes, since Protium will default on the loan. If things go well, however, Protium’s investors get all the upside since they get the residual cash flows after the loan is paid off. So Barclays is left with all the downside and none of the upside. In return for giving away the upside, they should have gotten a good interest rate on the loan. The interest rate is LIBOR + 275 bp, and I have no way of calculating if that’s a good rate or not. But even assuming it is a good interest rate, this is what Nassim Taleb calls a nickels strategy – picking up nickels (the nice interest rate) in front of a steamroller (the risk of the assets falling in value).

Finally, we have the other kind of arbitrage. Although Barclays is recognizing its exposure to Protium, Protium is a different company, and it’s not a bank. That’s important these days, and this is Tett’s main point. In particular, because it’s not a bank, British regulators can’t do anything to it. In particular, they can’t prevent Protium from paying its managers whatever they want to pay it, and they probably can’t force Protium to even tell them what its managers are making.

So here we have the ultimate form of regulatory arbitrage. If you’re a bank exec worried about public exposure or, even worse, regulation of your compensation, go create a new special-purpose vehicle to manage bank assets, entice the equity investors in with a sweetheart deal, and pay yourself whatever you want. Given the size of Barclays, the shareholders won’t notice $40 million here or there, especially if it looks like it’s coming from someone else. Everyone wins.

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    what happens if they default tomorrow?
    Sep 18 02:30 PM |Report abuse | Link | Reply
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    • Incorrect. Regulatory Authority and Regulatory transparency lose A.K.A "The Law". Will Fat Cat FSA do anything about it? Doubt it..
    via seekingalpha.com

    Fed Shoots a Regulatory Shot... But it's Just a Blank

    Friday, September 18, 2009


    I have no idea what this is from
    but somehow it is appropriate.
    Thank you again, Google image search.

    Tools? We have tons of them. Don't call the Fed impotent, you pricks, they have plenty of tools at their disposal even though ZIRP looks likely to stick around for quite some time.

    Oooh. Regulation and the Fed. Two of my favorite subjects in one delicious package of FAIL. I'm getting excited.

    Someone give them some porn mags.

    WaPo (who should be on JDA Watch right now for covering that ridiculous "racism" bullshit but I'll give them a pass because I have other things on my mind and can't entirely focus on this ridiculousness much longer):

    The Federal Reserve is moving to restrict compensation practices at the nation's banks, expanding its regulatory reach to oversee how tens of thousands of bank employees ranging from chief executives to loan officers are paid.

    The Fed, acting under its existing powers as a bank regulator, aims to curtail pay practices that can encourage bank employees to take the kinds of irresponsible risks that may have led to the financial crisis. It is not seeking to set caps on the amount any individual employee can be paid, said sources familiar with the plans.

    Fed officials and many private analysts have concluded that pay practices emphasizing short-term performance contributed to the near-collapse of the financial system last year.

    For example, a trader who receives bonuses based solely on one year's performance might make bets that pay off in the short run but cause vast losses in the long run. A loan officer paid only based on the volume of loans issued might not pay enough attention to the quality of those loans. Under the approach envisioned by the Fed, the two dozen or so largest banks would have to explain these pay practices to their regulator, and adjust them if examiners think they endanger the safety and soundness of the bank, said the sources, who spoke on condition of anonymity because the policy is not yet final.

    Some critics viewed the expected new regulations as a form of mission creep by the central bank, as it is being undertaken without explicit authorization from Congress. It comes as the Fed is facing extreme political pressure, under fire for its efforts to stabilize the financial system and for regulatory failures in the years before the crisis -- and as Chairman Ben S. Bernanke is up for Senate confirmation for a second term.

    via jrdeputyaccountant.com