Friday, 18 September 2009

Problem Solved?

EU leaders have voted on a new bank bonus clawback deal and they are all patting themselves on the back, smiling for the camera and can look to the renewed trust of their electorates that they have solved the issue that caused the crash of our financial system that in turn has cost each and everyone one of us so much money. Hurrah!

As the champagne starts to go flat at the end of a long day's celebrating and the last of the stragglers leave the party with ties askew, lipstick on their collar, silly hats on head and worse for wear, we should just ponder for a moment.

Let us do a thought experiment. You happen to know that your company bought a barrow load of sticking, rotten manure and it is sitting in a cupboard somewhere downstairs - a barrow load of manure they bought for $12.3bn when the market for manure was very good. So you think, 'I can deal with this'. The barrow load of manure is not only smelling the place out but, of course, it is sitting as a nasty debt on the company's books as the manure is now worthless. So you offer your company exactly what they paid for it - you would then transport it to a place where they don't mind what manure you want to store just as long as you pay good money to do so. In order to pay for the manure, you take a 10 year loan out from your company for $12.6bn.

You set up a nice company in the place you want to store the manure - the sort of place where no questions will be asked and no nasty hidden taxes are paid and where prying eyes are sightless. In return for the doing this, you resign, along with several colleagues who know as well as you that where there is manure there is money, from your company and they pay you an annual fee of $40m in order to 'manage' the manure.

The loan is a nice one - it is set at 2.75% above the US interbank rate which your company hopes will attract $3.9bn in profit over the course of the loan agreement. Only the interest is paid net of interest paid to the 'investors' in the storage company you have set up - let's call it Protium Finance for argument's sake. This investor income is at 7% of the $450m they have invested in Protium and their interest ranks higher than your company's.

Your company rubs its hands - it has cleared the debt off its accounts and on paper it will receive $16.6bn in 10 years time - it has been able to prove to the world that it no longer has the filth on its books and by doing this deal it appears it has bettered its capital ratio by getting its most toxic manure off its books. Meanwhile, you and your friends at Protium will be returning a sizeable profit to your investors who might be a US bank and a hedge fund, while your company will be paid from the manure's cashflow.

You see the manure could be replaced by toxic debt in this experiment and suddenly it does not look so ridiculous, pointless and downright stupid. Toxic debt has a 'cashflow' based on the assets supposedly. The 'Your Company' involved here is Barclays and Protium has indeed been set up by 45 of their employees who have now resigned to populate Protium Finance.

It does not matter how you account for this, the toxic debt remains a toxic debt and is highly risky. Barclays' CFO, Chris Lucas, stands and tells everyone that this is a good deal as it is producing a 'stable return profile for shareholders' as they rely on cashflows on such debts, so why not restructure them to rely on them and maximise shareholder value?

Protium has a recipe for the future - this will not be the only deal of this nature they will undertake. They will be the manure storage company of the future, state of the art facilities and discretion guaranteed as they operate out of the Cayman Islands.

This deal is nothing but straight forward, rotten manure. You can put your Palin-lipstick on the pig but it is still a pig. This is a deal that is at the very heart of a rotten and deeply flawed banking system. On the one hand, Barclays have 'cheated' the Government and regulators' capital ratio requirement by no longer appearing to have this toxic debt while the new Protium company is making money out of toxic manure fumes.

Have no doubt that this pile of manure/toxic debt will be worth its weight in gold after 9.99 years and by the 10th anniversary of the loan being taken out to pay for, it will be spread over the faces of plenty of people seated close to fans. The cleaning bill for their expensive suits and fast cars splattered by the mess will be picked up by yours truly.

This deal is the template for the next financial disaster and it illustrates why my blog of yesterday is true. Bonuses, and their culture, are not the problem per se, it is the flawed banking system that allows money to be made out of worthless piles of manure we euphemistically call toxic debt. It is the apparent intelligent thinking behind such a deal that defers the bad news to a point far in the future, long after many people will have made an absolute fortune out of the obvious - the obvious being that these toxic debts are nothing more than a pile of worthless manure. And manure is nothing more than manure, yet we will pay a princely sum to underwrite deals of this nature and that is what the whole financial industry now depends on - our enduring and bottomless pockets of money to pay for their profits and losses they make with total impunity.

This is the process of making money out of thin air and it is why bankers are a more aggressive, more risk taking then ever as they can make money out of losses. Does that sound stupid? It is because it is stupid. The massive losses that companies have made, the kinds that bust Lehmans Bros, are being openly traded again in order to make money from them - big money.

We haven't yet got a handle on how much this financial disaster will cost the world going forward but the bankers can tell you exactly how much profit they will make out of it. The response to this by the Treasury Select Committee Chairman, John McFall, merely claims this is 'sleight of hand' - Maradonna would have called it the financial equivalent of the 'hand of God'. Where are Hector Sants and Adair Turner of the FSA, Pinky and the Brain, as this goes on in full public view? Probably taking it easy talking up their futures with other agencies all around the world on large expense accounts and guaranteed bonuses.

Where are the politicians? They are still at the party congratulating themselves that they have stopped the financial world in its tracks - bonuses are curbed, problem solved.

Come again, what was the problem then, chaps?

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