Reporters, can you get the facts and run them by us one more time?
ASK THIS | October 01, 2008
Wick Sloane, MBA and all, has some basic questions about the current financial crisis. Like, for example, does anyone know how close we may be to finding our checking accounts inaccessible?
By Wick Sloane
Over in Beirut the other day, as the U.S. capital markets rocked and rolled, a travel agent refused a U.S.-bank-backed credit card. A reliable source says the man flipped the card over and over, rubbed it with his fingers, and held it up to the light, just as he would checking for counterfeit currency. No, he told my daughter, a Beirut schoolteacher trying to buy a ticket home for Christmas, he wouldn’t take the card for payment. “Let’s wait to see how this crisis turns out,” he said. Her parents, us, bought the ticket from here. U.S. dollars still worked.
Do any of us really how close we are to finding even our checking accounts empty or inaccessible? The press must ask this.
Acres of press coverage of the financial crisis continue to focus only on financial risk, not operational risk. Financial risk is whether a share in Company X worth $100 today will be worth $150 or $75 tomorrow. Operational risk is whether, if we sell the share for $100 today, we will ever receive the $100. Operational risk is whether the capital markets can complete the transactions required for our employer to have cash to meet the payroll and to complete the electronic funds transfer of our paycheck so that on payday we can put our debit card into the gas pump for a few gallons of $4 gasoline on the way home.
Call this crisis, for example, Hurricane Katrina. The financial risk is the severity of the storm. The operational risk is whether the levees will hold back the water. A financial transit system of staggering complexity moves the money through the global markets to our checking account to the gas pump and back again. How is this system doing in the hurricane? The Beirut travel agent wants to know.
What are SWIFT and SIBOS?
Trying “SWIFT”, the New York Times search engines offered a story “Bush Officials Urge ‘swift’ Action on Rescue Powers.” I tried “SWIFT, SIBOS.” “Did you mean swift silos?” the Times asked me. I did not. Nor was I looking for the stack of industry press releases that appeared. The Wall Street Journal search did pop up a sponsored link, inviting me to visit Booth B509 at Sibos. Closer, but no news stories on the crisis.
From the SWIFT home page: “SWIFT is the Society for Worldwide Interbank Financial Telecommunication, a member-owned cooperative through which the financial world conducts its business operations with speed, certainty and confidence. Over 8,300 banking organizations, securities institutions and corporate customers in more than 208 countries trust us every day to exchange millions of standardised financial messages.”
SIBOS was the SWIFT conference where 8,000 bankers and back-office professionals gathered in Vienna from September 15-19, for a regular meeting. If this financial crisis is Katrina and the operations risk is about the levees, those at SIBOS are the engineers. A friend from my days in the back offices of financial firms reported from Vienna that in just four days that week, these systems had settled $30 trillion in foreign exchange transactions alone. I think these systems and professionals are operating miraculously well, but that’s information from a week ago. Remember photographs from the 1970s and 1960s, of stacks of paper shares the securities industry had yet to settle, meaning no one knew who owed what to whom? These levees have broken before.
The press needs to ask, in as many ways as possible, whether the levees will hold this time. In Wall Street lingo that’s “How is the infrastructure holding up?” Communications, information flow, trade clearing and settlement, bookkeeping, segregation of "good" trades from "bad", throughput, capacity, resiliency? And the link to the gas pump?
What happened to Finance 101?
The fundamentals of finance are as simple as the jargon, the hedge funds, and the deals can be complex. For the potential of a higher return, the investor must take a higher risk. Risk means the chance of losing the investment. The base line for returns is U.S. Treasury securities. The returns are the lowest, as is, in theory, the risk of losing your money. The full faith and credit of the United State government, the theory goes, backs an investment in Treasury securities. For every basis point (1/100 of 1%) of yield above Treasuries, an investor is taking more risk. Risk is not good or bad. The same deal that is fine for you might be a disaster for me. Why? The other Vegas rule: Everyone in Vegas has the same upside potential; the question is who can afford to lose the bet.
These single-digit Treasury returns have been the source of ridicule for millions of U.S. investors, from individuals managing their own 401ks online to the hedge funds to pension managers. Why do money market funds pay more than bank savings accounts? Any securities other than U.S. Treasuries in a money market fund increase the chance that the investors will lose their money. Can press scrutiny cover the huge returns without also probing the risks?
“Would you run that by me again?”
No secret society, religious denomination or sporting event beats finance at intentional obfuscation. If something from Wall Street or global finance doesn’t make sense, consider that the situation or product just described doesn’t make sense. Ask again.
With my fresh MBA in the 1980s, I was assigned to a team for a new deal called financial guarantees of commercial real-estate transactions. The name “financial guarantee” should have been a hint. A colleague and I simply couldn’t make sense of the situation, save for the fees to all the lawyers and accountants and bankers around the table. Our betters told us that if we didn’t get it, we shouldn’t be working there. I shall live my life with the shame that I did what I was told. About five years later, tens of millions of other people’s savings went down the drain from those deals.
Where are they now? The champion of the program is president of the company where I make my mandatory pension deposits in my adjunct professor work.
Where did the money go?
I remember stories (from books, after the fact) from the 1987 U.S. stock market crash of how, as the DJIA dropped, anyone in a trading room could see the all the bond traders erupt into furious activity. Those selling stocks were moving the money to bonds. Most press coverage then kept on the equity crash, certainly a story, but neglected the rest of the story. A pileup in any capital markets segment risks starting another storm. If people, investors, are, for example, moving their money to cash but looking for cash accounts with the highest return, what does that mean? To achieve that higher return, the managers have to take on more risk. The safest investment, U.S. Treasury securities, is the lowest yield. If money is piling up today – the “flight to safety” – in other than U.S. Treasury securities, what are the investments backing those funds? What’s the risk?
The problem for the press is that the equity markets are action-packed, with scores and winners and losers every day. Watching paint dry has more action, today, than staring at a U.S. Treasury backed savings account.
One more – What about the FDIC?
FDR created the Federal Deposit Insurance Corporation to prevent panic and to give citizens a safe place, a bank, in which to keep their money. Then, as now, banks did not provide the highest returns. The low returns were meant to link to safer investments and, as a backup, the Federal government guaranteed deposits up to $100,000. We think this is still true. I’ve asked several officers at my bank about the guarantees on my money. The answers make no sense to me. What are the guarantees today? What is behind the guarantee?
In a commendable act of spin control, Yale, the source of my own MBA, sent all Yale alumni breathless notice of an instant roundtable of past and present deans and assorted other panjandrums “to discuss the unfolding situation in the markets and the economy more broadly, as well as the proposed Treasury Department bail-out plan currently being discussed in Congress.” I am sending queries to past and present business school deans to ask, “What has been going on in your classrooms for the past 25 years, to have produced this crew, who never knew to link increased returns to increased risk?” I e-mailed Linda Koch Lorimer, Yale Secretary and the messenger, to ask this. No reply.
But I need some help. I can’t cover the crisis finance and the crisis in education. I sit here with a stack of papers to correct for my English 111/College Writing I students at Bunker Hill Community College in Boston, where I am embedded to figure out why this nation cannot or will not educate the poor. Class tomorrow is at 7 A.M. In the spirit, then, of Wall Street guru Abbie Hoffman, who in 1967 showered the floor of the New York Stock Exchange with cash, please, “Steal these stories!”